By Adam K. Wright, CFA®, CFP®
Banks play a vital role in the economy, providing individuals and businesses with access to cash, credit, and other financial services. Despite their importance, however, banks can fail. And when they do, the effects often cause panic in the wider economic environment.
This past week, two major players in the banking industry, Silicon Valley Bank and Signature Bank, collapsed after they had trouble raising capital to meet the demand for deposits. While there are several reasons why experts believe these failures are not part of a more significant economic crisis, it is understandable if you are worried. These were the second and third largest bank failures in U.S. history, behind only the collapse of Washington Mutual in 2008.
Given the news headlines surrounding Silicon Valley Bank, we want to provide you with a market update. This should arm you with the right information and to let you know our stance regarding your financial progress.
Ultimately, we’re well positioned and don’t recommend any action. The recent news has been quite complex, though, so I’ll do my best to update you on recent developments in clear terms without the jargon.
Why Do Banks Fail?
Banks can fail for several reasons, including undercapitalization, liquidity issues, safety and soundness concerns, and fraud.
- Undercapitalization occurs when a bank has insufficient capital reserves to cover ordinary business expenses or meet regulatory requirements, which leaves it vulnerable to financial shocks. For instance, a bank that has issues generating cash flow or accessing financing in the form of debt or equity may find itself undercapitalized.
- Liquidity issues arise when a bank lacks sufficient cash or liquid assets to meet its obligations, which can happen when a large number of depositors withdraw their funds all at once.
- Safety and soundness concerns occur when a bank engages in risky lending practices, such as offering subprime loans or investing in volatile assets. This was a big issue during the 2008 financial crisis when several major banks failed due to their investments in subprime mortgages.
- Fraudulent activities, such as embezzlement or insider trading, can cause significant financial losses for a bank and erode depositor confidence.
Banks that fail to manage these risks effectively may become insolvent and ultimately fail, jeopardizing the stability of the financial system and the broader economy.
What Happened with SVB & Signature?
SVB and Signature Bank both failed due to liquidity issues stemming from what’s known as a bank run. A bank run occurs when a large number of depositors withdraw their funds from a bank over a very short period of time (usually days). Because banks invest the cash deposited with them, a high demand for withdrawals can force the banks to sell off investments at a poor market price in order to meet the liquidity need. Consistently selling assets at a substantial loss can exacerbate liquidity issues and quickly cause a bank to become insolvent.
A simple timeline of events:
- Silicon Valley Bank was doing well in the tech boom. It enjoyed a huge increase in deposits following COVID as the tech sector boomed, mostly from large venture capital businesses, with the money held on deposit with SVB tripling between 2019 and 2021. The bank had to put this money to work.
- The size of the deposits became sizeable, well above FDIC Insurance limits, so they invested a large portion in long-term bonds, earning approximately 1.56% with an average maturity date of over 10 years. This saw positive gains for a while, as the 1.56% rate was above the rate the bank pays on deposits, but it quickly unfolded.
- The Federal Reserve increased interest rates, with the amount SVB paying to deposit holders growing to 4.50% per annum for start-ups. This was considerably beyond the 1.56% they were receiving on the bonds. The assets they held in bonds also fell in value, creating a double hit.
- In response, SVB tried to prop up their balance sheet by selling assets…at massive losses. People became skittish and quickly withdrew their money, creating a classic bank run. SVB was left with no liquidity and major losses, forcing them to default.
If you’d like to know about this in more depth, there is a lot of information out there, but this piece from Morningstar is a great starting point.
A similar story unfolded at Signature Bank, which served mostly crypto investors. Similar to the depositors at SVB, many of the accounts held at Signature Bank were well above the FDIC-insured limits. Spooked by the failure of SVB, depositors at Signature Bank withdrew over $10 billion on Friday, March 10th. By Sunday, March 12th, the bank was taken over by the FDIC to protect the stability of the U.S. banking system.
What to Expect From Other Banks
For most investors, the biggest question is whether or not this can spread to other banks. We’d argue that while the rapid rise in interest rates has caused some short-term losses for the banking industry that are meaningful, industry capital levels are better positioned to weather the storm. We also believe the regulatory response from the Federal Reserve, the FDIC, and the U.S. Department of the Treasury has been quick, unified, and substantive. In the short term, we’d not be surprised to see market volatility remain elevated, reflecting the increased uncertainty around potential outcomes, but most banks have much more diversified sources of funding, and lend to a much wider range of industries.
So far, small and midsize banks that tend to focus on niche clientele are the most at risk. For instance, banks focused on tech and crypto may be significantly more exposed, as many companies in these industries operate with negative cash flows that require ongoing funding. If the funding dries up, this can cause severe stress.
The market can be undiscerning at times, especially during a panic. Shares of regional bank stocks took a beating on Monday, March 13th, as investors tried to process the news of SVB and Signature Bank. First Republic Bank was down over 60%. Larger banks, including Wells Fargo, Bank of America, and JPMorgan were less affected, falling just 7%, 3%, and 1%, respectively.
What to Know About FDIC Insurance
Despite the uncertainty surrounding the health of the overall banking system, there are safeguards in place to protect depositors and investors from losing their hard-earned savings.
The Federal Deposit Insurance Corporation (FDIC) and Securities Investor Protection Corporation (SIPC) provide insurance to preserve your assets.
The FDIC is an independent U.S. government agency that was established in 1933 to insure bank deposits. The FDIC insures deposits up to $250,000 per depositor, per account ownership category, per bank. This coverage includes checking accounts, savings accounts, money market accounts, and certificates of deposit (CDs) issued by FDIC-insured banks.
Not all banks are FDIC insured, so be sure to double-check the status of your accounts and consider relocating your funds if your bank is uninsured.
Additionally, FDIC insurance has limits to its coverage. The FDIC insures up to $250,000 per depositor, per account ownership category, per bank. Keep in mind that joint accounts are considered a separate ownership category, which means that each account holder is insured up to $250,000 under the FDIC program.
If you have accounts with multiple banks, make sure your deposits and securities are spread out in a way that maximizes your insurance coverage. Remember to regularly review your account balances and adjust your accounts as necessary to ensure you are within the coverage limits. By knowing the coverage limits and eligibility requirements, you can make informed decisions when choosing where to deposit your money.
What to Do Now
At the core, client portfolios hold a wide range of assets that are diversified by sector, industry, geography, and designed to navigate broad risk factors. As long-term and wisely contrarian investors, this type of setup is one that we’d use to begin searching for opportunities. We obviously want to express this in your portfolio, but it is worth remembering that we want a margin of safety for any risk taken.
More often than not, the only glaringly obvious thing to do is known with hindsight. Owning broadly diversified portfolios that are in line with your retirement and investment plan usually does not warrant big actions from big headlines. If nothing else, stay the course, continue contributing to your account, and keep the long term in mind. Financial market history is littered with (hopefully) mini-crises like SVB and SB.
How We Can Help
In situations like this, we have three responsibilities. The first is to support you in helping you understand what matters and what doesn’t. The second is to ensure we are monitoring risks and investing in line with your risk tolerance. And third, we want to find opportunities to reach your goals faster, come what may. Our actions are always oriented toward your financial plan and making decisions consistently over time.
If you’re worried about the recent bank failures and how they might impact your finances, don’t hesitate to reach out to us for guidance. Our team can help you understand your options and develop a plan to protect your assets, minimize your risk, and provide advice on FDIC and SIPC insurance. Schedule a complimentary phone call to get started.
Adam Wright is a CERTIFIED FINANCIAL PLANNER™ professional at Wright Associates, helping clients plan and prepare their investments to retire on their terms. If you’re serious about planning for your retirement and investing for your future, his annual process will help you make the right money choices today. Therefore, Adam and his team will proactively manage your accounts while communicating the progress of your financial plans. He believes the retirement advice you receive should be intentional and actionable.
Adam has a Bachelor of Science in Supply Chain and Information Systems from The Pennsylvania State University and a Master of Business Administration from University of Pittsburgh, Katz Graduate School of Business. He lives in Upper St. Clair with his wife and two children. When he’s not working, Adam enjoys the outdoors (fly fishing), reading, and taking long runs while listening to a favorite podcast. He’s also currently encouraging himself to take up golf. To learn more about Adam, connect with him on LinkedIn.