The simmering banking crisis in the US

The rapid and alarming collapse of three American banks — Silicon Valley, Silvergate and Signature — within a week has rocked public confidence and sparked significant anxiety about the reliability of the US banking system and the possibility of a broader crisis in the financial sector. 

Silicon Valley Bank (SVB), a lender that primarily served startups, has become the largest bank to collapse since the 2008 financial crisis and the second-largest bank failure in US history. At the end of 2022, the bank held approximately $209 billion in total assets and about $175.4 billion in total deposits, making it the 16th largest bank in the United States. 

On 10 March, California banking regulators closed the 40-year-old institution and appointed the Federal Deposit Insurance Corporation as the receiver responsible for managing its assets. Despite efforts by President Joe Biden and US regulators to reassure the American people that their “banking system and money are safe”, the reality that American banks are facing unrealised losses of over $600 billion paints a very murky picture of this sector. 

Many are questioning the role of the Federal Reserve in this saga. There are worries that the recent failures of banks in the US could trigger a series of bank runs. According to many analysts, the primary cause for the sudden collapse of the bank is the Federal Reserve’s aggressive interest rate hikes over the past year. These higher interest rates instigated the closure of the initial public offerings market for many startups and made private fundraising more expensive. 

SVB’s focus on providing banking services to technology, life science and healthcare companies — key players in the venture capital ecosystem — made it particularly vulnerable to market fluctuations. The bank’s heavy concentration in this type of client profile had put it at significant risk. 

On 15 March, in a desperate attempt to raise funds for redemptions, SVB sold a bond portfolio worth $21 billion, mainly comprising US Treasuries, at a loss of $1.8 billion. However, this move was unsuccessful in halting a run on deposits, as numerous customers held more than the $250 000 limit that is covered by US insurance institutions. As a result, customers began withdrawing their funds en masse. Before the bank’s ultimate collapse on 17 March, depositors attempted to withdraw $42 billion from the institution the previous day. In the days leading up to this event, there was a flurry of activity as regulators worked to prevent a potential contagion effect on other financial institutions. 

The collapse of SVB has drawn scrutiny to the hazards that financial institutions face due to the Federal Reserve’s assertive measures aimed at combating inflation. In a high-rate environment, bonds experience a decline in value as yields increase. Last year, US benchmark 10-year yields skyrocketed by over 200 basis points, and in February alone, they surged by almost 40 basis points, preempting  the renewed expectations for interest rate hikes. 

Are we going to witness the repetition of the 2008 meltdown? The answer is “no”. Let’s clarify why the situation is distinct from the 2008 global financial crisis. To begin with, when Lehman Brothers and Bear Stearns — leading investment banks — went bankrupt, these institutions were intertwined throughout the global economy, making their collapse have an enormous global impact. In contrast, SVB, Signature, and Silvergate in the US are small institutions compared to the larger investment banks. Furthermore, these banks are not as heavily interweaved with the global financial system. While they might be crucial to their depositors and users, they do not possess the same extensive international connections that can trigger a chain reaction in the world economy, as was the case during the global financial crisis.

The bitter reality is that the Federal Reserve is grappling with a predicament of its own making. It had maintained a zero interest-rate policy for seven years without planning for its eventual end at some point. However, the bonds acquired during that period depreciated as interest rates increased and these rates did not increase gradually. The Federal Reserve raised interest rates to an unprecedented level, causing significant difficulties for developing businesses. The US is witnessing how those rate hikes affected the assets of American citizens. 

Another factor to consider in this crisis is the role of regulation. Ironically, SVB was among those leading the charge to relax bank regulations for smaller and mid-tier banks and they succeeded in 2018 during the Trump era. While having regulations in place may not have completely prevented the crisis at SVB, it would have required them to have a risk-management system in place and would have alerted them to the problem much earlier. 

However, many small US banks are facing a similar plight to SVB. In addition, the high US dollar interest rates are causing capital outflows from emerging markets, and several countries are experiencing higher debt costs, which could lead to financial crises in some regions. US banks have grown accustomed to a low interest rate environment over the past decade. As a result, the US Federal Reserve’s aggressive interest rate hikes since March 2022 have made banks like SVB more vulnerable. 

Although the turbulence in the US banking system resulting from the abrupt failures of SVB and Signature appears to be easing, the commotion, combined with uncertainty in the market regarding the Federal Reserve’s interest rate policies and persistently high inflation, will probably continue to undermine the trust of US depositors and create a growing sense of uncertainty across the globe. 

Almost 14 years have elapsed since the 2008 financial crisis but the US financial system has not learnt anything from that episode and is still plagued by confusing loopholes. The regulation and oversight of US banks and other financial institutions continue to be problematic. It is still too soon to determine whether other US market participants will follow in the footsteps of the aforementioned trio and shut down this year. 

Compounding the issue, the impact of the failing US banks appears to be spreading to Europe, with Credit Suisse, a banking behemoth, receiving an emergency infusion of $54 billion in liquidity from Switzerland’s central bank last week to stay afloat. The apprehension of investors is unlikely to dissipate in the coming weeks, as some experts caution that this could merely be the initial stage of a domino-like cascade. 

Moreover, there may be additional risks still unnoticed and concealed within the financial system, particularly following the rapid escalation in interest rates by the US Fed and other Western central banks over the past year. For instance, the European Central Bank recently opted to raise the eurozone’s benchmark rates by an additional half-point, which is anticipated to create substantial economic strain and significantly increase the financial burden on banks. The US Fed is also expected to raise the federal funds rate by 25 basis points in March, which will further intensify pressure on the US economy and its financial system. 

The chaos in US financial markets is compounded by the troubling undercurrent of an impending banking crisis, as stubborn inflationary pressures persist. If the US central bank continues with aggressively increasing interest rates, the strain on US lenders, private equity funds, real estate developers and other institutions will only increase.