A new report has found that 186 banks in the US are at risk of failure due to rising interest rates and a high proportion of uninsured deposits. The research, posted on the Social Science Research Network titled 'Monetary Tightening and US Bank Fragility in 2023: Mark-to-Market Losses and Uninsured Depositor Runs?' estimated the market value loss of individual banks' assets during the Federal Reserve's rate-increasing campaign. Assets such as Treasury notes and mortgage loans can decrease in value when new bonds have higher rates.
The study also examined the proportion of banks' funding that comes from uninsured depositors with accounts worth over $250,000.
If half of the uninsured depositors quickly withdrew their funds from these 186 banks, even insured depositors may face impairments as the banks would not have enough assets to make all depositors whole. This could potentially force the FDIC to step in, according to the paper.
However, it is important to note that the research does not consider hedging, which may protect many banks against rising interest rates.
"Even if only half of uninsured depositors decide to withdraw, almost 190 banks are at a potential risk of impairment to insured depositors, with potentially $300 billion of insured deposits at risk. If uninsured deposit withdrawals cause even small fire sales, substantially more banks are at risk," the report noted.
The failure of Silicon Valley Bank serves as an example of the risks posed by rising interest rates and uninsured deposits. The bank's assets lost value due to the rate increases, and worried customers withdrew their uninsured deposits. As a result, the bank failed to meet its obligations to its depositors and was forced to close.
The economists who conducted the study warned that these 186 banks are at risk of a similar fate without government intervention or recapitalization. The findings underscore the importance of careful risk management and diversification of funding sources for banks to ensure their stability in the face of market fluctuations.
Silicon Valley Bank collapse
Silicon Valley Bank, once a prominent player in the banking industry, collapsed after struggling to cope with rising yields that eroded the value of its assets. The bank was shut down by Californian regulators last Friday, and the Federal Deposit Insurance Corporation (FDIC) was appointed as the receiver. This marks the largest bank failure since the financial crisis of 2008 when Washington Mutual went bust.
Silicon Valley Bank attempted to recover from its losses by selling a portfolio of treasuries and mortgage-backed securities to Goldman Sachs at a loss of $1.8 billion. However, it failed to raise $2.25 billion in common equity and preferred convertible stock to plug the hole. The bank's clients became increasingly worried and withdrew their deposits, causing $42 billion in outflows in just one day.
In an attempt to salvage its businesses, Silicon Valley Bank announced earlier this week that it was exploring strategic alternatives for its holding company, SVB Capital, and SVB Securities.
The company said that SVB Securities and SVB Capital's funds and general partner entities were not included in the Chapter 11 filing. The company added that it planned to proceed with the process to evaluate alternatives for its businesses, as well as its other assets and investments.
Also read:FDIC takes control of collapsed Silicon Valley Bank, retains employees for 45 days at 1.5x salary
As a seasoned financial analyst with a background in banking and monetary policy, I bring a wealth of knowledge to the discussion on the potential risks outlined in the recent report concerning 186 banks in the US. My expertise is rooted in years of hands-on experience in analyzing market trends, assessing the impact of interest rate fluctuations on financial institutions, and understanding the intricacies of banking regulations.
Let's delve into the key concepts mentioned in the article:
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Monetary Tightening and US Bank Fragility in 2023: Mark-to-Market Losses and Uninsured Depositor Runs?:
- The report focuses on the vulnerability of 186 banks in the US due to rising interest rates and a high proportion of uninsured deposits.
- Mark-to-market losses are estimated for individual banks' assets during the Federal Reserve's rate-increasing campaign, considering assets like Treasury notes and mortgage loans that can decrease in value with higher rates.
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Market Value Losses and Uninsured Depositor Runs:
- The study assesses the potential market value loss of assets if half of the uninsured depositors withdraw their funds from the at-risk banks.
- The concern is that even insured depositors may face impairments if the banks lack sufficient assets to cover all depositors, potentially leading to FDIC intervention.
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Role of Hedging and Lack of Consideration:
- The report acknowledges that it does not consider hedging, highlighting a limitation in the analysis. Hedging strategies could protect banks against the adverse effects of rising interest rates.
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Silicon Valley Bank Case Study:
- The collapse of Silicon Valley Bank serves as a real-world example of the risks posed by rising interest rates and uninsured deposits.
- The bank's assets lost value due to rate increases, leading to a withdrawal of uninsured deposits and ultimately causing the bank to fail.
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FDIC Intervention and Bank Failure:
- The FDIC stepped in as the receiver for Silicon Valley Bank, emphasizing the potential need for government intervention in cases of bank failure.
- The article notes that if the 186 banks face a fate similar to Silicon Valley Bank, government intervention or recapitalization may be necessary to prevent widespread financial repercussions.
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Importance of Risk Management and Diversification:
- The economists conducting the study highlight the importance of careful risk management and diversification of funding sources for banks to ensure stability amid market fluctuations.
In conclusion, the insights provided by the report underscore the critical need for proactive risk management and regulatory measures to safeguard the stability of the banking sector in the face of economic uncertainties and rising interest rates. The Silicon Valley Bank case serves as a cautionary tale, emphasizing the potential consequences if such risks are not adequately addressed.
