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When First Republic Bank collapsed earlier this week, some bankers like the head of JPMorgan Chase & Co. said they thought the worst of the banking crisis was coming to a close.
But the markets are showing investors are still wary.
San Francisco-based PacWest Bancorp’s shares plunged more than 39% Wednesday night and were halted for volatility multiple times Thursday after investors learned the regional bank was considering a sale. While the bank says it has not experienced a high number of customer withdrawals, the news still stoked fears of a potential surge in withdrawals among regional banks.
Regional banks whose shares are falling include Zions Bancorp and Comerica, whose stock dropped more than 12% on Thursday, and KeyCorp, whose stock dropped more than 6%.
Meanwhile, TD Bank Group and First Horizon Corp. called off their planned merger on Thursday, citing uncertainties around regulatory approvals.
So what’s next for the banking industry, and how does it affect consumers?
What are the reasons the 3 big banks failed, and PacWest is looking shaky?
As the Federal Reserve tightened monetary policy and raised interest rates to fight inflation, the value of long-term assets − such as mortgage-backed securities and U.S. treasury bonds −held by banks plummeted.
Most bonds pay a fixed interest rate that becomes attractive when interest rates fall, driving up demand and the price of the bond. On the other hand, if interest rates rise, investors will no longer prefer the lower fixed interest rate paid by a bond, thus driving down its price.
Many banks increased their holdings of bonds during the pandemic, when deposits were plentiful but loan demand and yields were weak.
For some banks, the unrealized losses brought on by the Fed’s sudden interest-rate hikes will stay on paper. But others may face actual losses if they have to sell securities for liquidity or other reasons. That’s because those older bonds with low interest rates could be sold only at much lower prices than new bonds that carry higher rates, according to the Federal Reserve Bank of St. Louis.
That, in a nutshell, is what happened to Silicon Valley Bank, when turmoil in the tech world forced many of the banks’ customers – largely tech startups – to withdraw their deposits.
In addition, Silicon Valley Bank had a disproportional share of uninsured deposits (any amounts over that $250,000 limit are considered uninsured deposits by the Federal Deposit Insurance Corporation, or FDIC), with only 1% of banks having higher uninsured leverage, according to a study.
Like First Republic Bank, Pacific Western Bank lost 20% of customer deposits compared to the end of last year as customers moved their deposits to the perceived safety of larger banks.
“Silicon Valley Bank failed because of a textbook case of mismanagement by the bank. Its senior leadership failed to manage basic interest rate and liquidity risk. Its board of directors failed to oversee senior leadership and hold them accountable. And Federal Reserve supervisors failed to take forceful enough action,” according to a scathing Federal Reserve report released last week.
What is being done to try to fix this?
In a recent report, the Fed made recommendations to strengthen its supervision and regulation and said it will be focusing on improving the speed, force and agility of supervision.
The Fed has begun to build a dedicated supervisory group to focus on the risks of novel activities (such as fintech or crypto activities) as a complement to existing supervisory teams.
“As we do so, we will identify whether there are other risk factors—such as high growth or concentration—that warrant additional supervisory attention,” says Michael S Barr, Vice Chair for Supervision at the Federal Reserve Bank.
Currently, the Fed generally does not require additional capital or liquidity beyond regulatory requirements for a firm with inadequate capital planning, liquidity risk management, or governance and controls.
“We need to change that in appropriate cases,” says Barr. “Higher capital or liquidity requirements can serve as an important safeguard until risk controls improve, and they can focus management’s attention on the most critical issues.”
The Fed will also evaluate how it supervises and regulates liquidity risk, starting with the risks of uninsured deposits.
Could the government do more?
Currently, the FDIC covers up to $250,000 worth of deposits at FDIC-insured banks.
Some say the FDIC protection does not go far enough amid the banking crisis and have called on the Biden administration to guarantee all U.S. bank deposits.
Hedge-fund billionaire Bill Ackman on Twitter argued that the First Republic would not have failed if the FDIC temporarily guaranteed deposits while a new guarantee regime was being created.
“Banking is a confidence game,” Ackman wrote. “At this rate, no regional bank can survive bad news or bad data as a stock price plunge inevitably follows, insured and uninsured deposits are withdrawn and ‘pursuing strategic alternatives’ means an FDIC shutdown over the coming weekend.”
Bloomberg reported earlier this year that a coalition of midsized banks is pushing for the FDIC to extend its insurance to cover all deposits over the next two years.
The FDIC released a report Monday that examined a variety of ways to reform the bank deposit insurance system. Of the three options laid out in the report, the FDIC favored a move that would “significantly” increase deposit insurance coverage on bank accounts used for business purposes.
This option is the “most promising option to improve financial stability relative to its effects on bank risk-taking, bank funding, and broader markets,” the FDIC report said.
The agency’s report also looked into providing unlimited deposit insurance for all deposits but warned this could incentivize more risk-taking among banks.
Are there concerns of a bigger problem? And how would you be affected?
Can we expect more banks to collapse? Possibly.
A study on the fragility of the U.S. banking system published on the Social Science Research Network in March found 186 more banks are at risk of failure, even if only half of their depositors decide to withdraw their funds.
Economists say more bank runs could pose a risk to even insured depositors who have less than $250,000 in the bank as the FDIC’s deposit insurance fund starts incurring losses, but only if the government fails to step in.
Is your money in a bank safe?
Research indicates Americans are increasingly worried about the safety of their money in the bank. A recent Gallup poll found 48% of U.S. adults say they are concerned about the safety of money they have deposited in banks and other financial institutions. The poll was conducted on a random sample of more than 1,000 U.S. adults in April following the collapse of Silicon Valley Bank and Signature Bank but before First Republic Bank failed.
Experts have said there’s no reason customers should worry about money kept in banks that are covered by the FDIC, especially since few depositors surpass the $250,000 limit on the insurance.
Depositors concerned about the limit can open multiple accounts at different banks to keep accounts under the $250,000 cap, or open a joint checking account that would insure up to a total of $500,000 in the account ($250,000 per person).
Federal regulators have signaled that even for depositors who surpass the $250,000 limit, the government is likely to intervene and make sure deposits are covered as they did after Silicon Valley Bank, Signature Bank and First Republic Bank collapsed.
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