The recent collapses of Silicon Valley Bank (SVB) and Signature Bank have sent shockwaves through the investment markets. SVB’s collapse was the second largest in history given that the bank had $175B in deposits and $209B in assets.
Many think that larger banks, given their size, cannot fail. This is obviously untrue given recent history.
The question becomes how can this happen, and how can we protect ourselves from a potential bank failure?
Rule #1 is that any bank can fail. Period. End of story. Forgetabadit. Although smaller banks fail easier than larger ones, no banking institution is perfectly safe.
Banks take your deposits and either lend them to borrowers or invest the money. These are the two main ways that banks make money and pay their bills.
The FDIC has solvency requirements depending on the type of deposit. This requirement is generally 20%, which means that if a bank has $100M in deposits, it could either lend or invest $80M of that money. These solvency ratios have in some cases gone down substantially, requiring banks to keep even less money on deposit.
In the case of SVB, they invested a substantial amount of their deposits into bonds. The value of bonds have an inverse relationship between interest rates and value.
As interest rates increase, the value of the bond decreases. The opposite is true as well. If interest rates go down, then the value of bonds will go up.
SVB bought billions of dollars in bonds a couple of years ago when interest rates were well under a percentage point. Then Moody’s, one of the agencies that provides ratings on financial institutions, threatened to downgrade the bank’s rating.
This caused a run on the bank. A run is defined as a substantial amount of depositors taking cash out of the bank. Remember that banks normally keep somewhere around 20% of your deposits inside the bank.
Normal activity doesn’t usually cause a problem. Between people making deposits and taking money out on a daily basis, there might be minor adjustments, but this generally doesn’t cause a major problem.
But if even a small amount, like10% of a bank’s depositors, want to take their money out in a short amount of time, then the bank must maintain its solvency. This is what happened to SVB.
In order to maintain its solvency the bank raised cash by selling bonds. In the interim period, interest rates had gone up substantially, which dropped the proceeds from the sale of the bonds by upwards of 20%. This caused the bank to fail.
The intricacies are much more complicated than that, but that’s basically what happened. Given what has happened to interest rates, it will probably happen to more banks, hence my communication today.
Let me leave you with this.
The FDIC insurance limit is $250K per depositor, per bank. This means that only the first $250K of your deposits are truly safe.
In any bank, there are insured deposits and uninsured deposits. If you have $300K sitting in a checking account, this means that $250K of it is insured, and $50K is uninsured.
If the bank went down, you could potentially lose $50K.
In the instance of SVB, because it handled primarily large tech based depositors, 90% of its deposits were uninsured. The federal government has stepped in and guaranteed all of the deposits which means that part of your tax bill will now be going to pay for someone else’s mistake. Again.
This isn’t going to continue happening. It’s not something you can bank on.
If you have more than $250K sitting in a bank, then invest the excess. Do something to hedge against inflation. At the very least, open another checking account at another bank and keep your individual deposits under the FDIC insurance amount.
These recent events are only the opening salvo. As the economy worsens, this problem isn’t going to get better.
We’re all staring at a real estate recession which will only add to the solvency issues at the bank of your choice. This will probably force even more to go down.
Be smart with your money. Spread the risk.
We’re all going to get through this. Let’s get through it together.
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