We Must Be Prepared For A Slow-Motion Banking Crisis As A Rapid-Finance World

It is important to understand that in recent decades financial crises have tended to be fast-moving, violent, and did not all occur simultaneously. Instead, they tend to affect a handful of companies or countries, and they usually peak the weekend before Asian markets open. 

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With the collapse of Silicon Valley Bank and Signature Bank this month as well as the forced merger of Credit Suisse with UBS Group AG, this template could provide some hope that the worst of the current turmoil may have passed. These events, as well as the federal backstops implemented in response to them, have also given rise to renewed hope that the worst of the current turmoil may have passed.  

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In addition to the corrosive, slow-motion crisis, there is also another template that could be used. SVB collapsed as a result of a confluence of structural factors, some of which affect many institutions to a lesser degree nowadays. As a result, many banks will be forced to shrink or be acquired in the coming years, which is also going to hamper the credit supply.  

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Historically, financial crises around the world have tended to take years to unfold. Between the years 1980 and 1994 in the United States, roughly 3,000 mostly small savings and loan institutions and banks were bailed out or closed by government agencies. 

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When the Federal Reserve pushed interest rates up sharply, it prompted major financial institutions and savings and loan associations to struggle to compete with banks and other financial institutions that were at the mercy of rising interest rates on deposits and money market funds. 

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There was a similar start to the current episode as it did in previous episodes. Since the Fed kept interest rates low from 2008 through 2021, banks have been increasing their stock holdings of government bonds, and federally backed mortgage bonds, as a means of gaining yields on their investments. A sharp decline in bond market value occurred in 2022 after interest rates began to rise sharply. Although this loss was particularly severe for SVB, it was not the only company that experienced such losses. There are around 500 banks in the United States, in total, that have suffered greater percentage losses from higher interest rates than SVB, according to a Stanford University finance professor named Amit Seru and his three co-authors.

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It is nevertheless important to note that in past crises, defaults were ultimately more significant than interest rates. As a result of recession, overbuilding, and a collapse in oil and gas prices, commercial real-estate loans were heavily impacted during the 1980s. The subprime mortgage bubble and related derivatives were in full swing in 2007-2009, as Mexico and other emerging economies defaulted on loans to money center banks. 

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In the third quarter of 2022, as measured by S&P Global Ratings, 86% of banks’ securities were federally backed, compared with 71% by the third quarter of 2008 (the rest is made up of corporate bonds, privately owned mortgages and asset-backed securities). The sector is now more optimistic about its credit picture.

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As Chris Whalen points out, the value of collateral such as cars, as well as other forms of collateral, has been so high in recent years that banks have benefitted from unusually low credit losses, which has enabled them to increase their credit levels. In particular, small banks are exposed to commercial real estate, which means that losses are going to mount.

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Even so, it is worth noting that, although a recession could lead to a rise in defaults, it might also bring a decline in interest rates, which will boost bond portfolio prices. In fact, total unrealized losses have dropped in the last quarter of 2022 as yields on bonds have declined. 

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Bank balance sheets today are more concerned about their liabilities than their assets in comparison with the past and that poses a greater challenge for the banks. 

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As a result of the monetary and fiscal policy response to the pandemic, the United States has experienced significant economic growth in the recent past. As a result, a significant amount of stimulus was sent directly to household bank accounts by the Federal Reserve, and the Treasury sent big stimulus payments and other relief payments directly to households. As a result, deposits ballooned. Moody's Investors Service reported that, according to Moody's Investor Service, the ratio of bank loans to deposits dropped to a 50-year low of 60 percent in September 2021.  

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The trend of an increasing share of uninsured deposits in bank accounts was a concern several years ago, but it was assumed that they would be relatively "sticky" in terms of fleeing, or less susceptible to this type of behavior than other wholesale funding sources. 

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It has been observed that online banking has become much more popular since it was first developed in the early '90s, although statistics also suggest that it will become even more popular in the coming years. The share of bank customers using mobile or internet banking is expected to rise from 52% in 2017 to around 66% by 2021. 

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In the beginning, when interest rates were near zero, depositors had little reason to look for higher-paying investments. However, this didn't matter when rates were near zero. In the past year, when the Fed raised interest rates toward 4%, savers began to move out: deposits have been shrinking for the past year. In part, this is due to the Fed reversing its bond purchases, soaking up some of the excess deposits and reserves held by banks.

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It was reported that in 2007 Northern Rock failed British lender, Northern Rock, whose website crashed, leaving customers to withdraw money through branches. Bianco Research in Chicago pointed out that the site did not crash this time around. During the week of March 9th, SVB's deposit outflows reached an astonishing $42 billion, and they were on track to reach $100 billion a day later, according to Michael Barr, the Fed's vice chairman for banking supervision. 

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A few weeks ago, the Fed announced a real-time payments service called FedNow that could allow bank customers to transfer funds instantly, without having to wait in line for the transaction to settle. Mr. Bianco predicted that such flows would become even more frictionless after FedNow is launched in July. 

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There is an obvious change in deposit behavior. It appears they will be more sensitive to market conditions than to deposit rates in the near future.

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It is likely that depositors will tend to move their money into banks they believe to be too big to fail as a result of this, which will hurt smaller and regional lenders the most. Moreover, the Federal Reserve reported that smaller banks lost $120 billion in deposits during the week ending March 15, while the biggest banks gained $66 billion. Daleep Singh, a former economic adviser to President Biden and now chief economist at PGIM Fixed Income, said in a recent interview with the Journal that he had serious concerns about the deposit franchise value at midsize banks. In his opinion, it would be rational to move deposits in small businesses or savings accounts over the $250,000 federally insured limit to "safer alternatives" if the money was to be safe.

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In its recent downgrade of the U.S. banking system's credit rating, Moody's, too, cited the threat to many lenders' deposits. Those banks that have substantial unrealized securities losses, and who have non-retail and uninsured US depositors, may also be more vulnerable to depositor competition or flight, which could adversely affect funding, liquidity, earnings and capital. Inflation will remain high until the Fed returns it to its 2% target, which will add to these pressures. High interest rates will increase the pressures until the Fed targets this rate of 2%. 

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This indicates that small and medium-sized banks may face a prolonged period of stress on their deposits if federal insurance is not extended to all deposits. This could result in the banks being forced to be acquired, or their lending being restricted, as a result. Certainly, it will not be a crisis as we usually understand the term, but it may lead to the same outcome.