Taylor Scott
The collapse of Silicon Valley Bank, Signature Bank, and others in 2023 has brought to light the risk of other banks failing. Since 2001, there have been 567 bank failures, with 15 banks collapsing since 2019. Rising interest rates, a decline in the value of bank assets, and a high proportion of uninsured deposits are some of the factors contributing to this risk. Almost 300 banks are at a higher risk of failure, and if a large number of these banks were to fail, it could trigger a domino effect, impacting the broader economy. While predicting specific banks in danger is challenging, the current climate suggests potential risks for the banking sector.
| Characteristics | Values |
|---|---|
| Number of banks at risk of collapse | 186-300 |
| Number of bank failures from 2001-2024 | 567 |
| Number of bank failures since 2019 | 15 |
| Reason for collapse | Unrealized investment losses, overreliance on uninsured deposits, suspected fraud |
| Impact of collapse | Domino effect, credit crunch, loss of confidence in the banking system, recession, financial crisis |
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What You'll Learn
Unrealized investment losses
Banks hold investment securities, and significant drops in their value can erode a bank's capital base. Unrealized losses on investment securities occur when the market value of a security decreases below its book value. These losses can be caused by various factors, such as rising interest rates, which decrease the value of long-maturity securities. During 2022–2023, rapidly rising interest rates contributed to larger unrealized losses in banks' securities portfolios. The Federal Reserve's efforts to combat inflation by raising rates have led to a jump in the 10-year Treasury yield, causing substantial losses for banks.
The impact of unrealized investment losses can be significant, as evidenced by the collapse of Silicon Valley Bank, which triggered turmoil in the banking industry. Regional banks with large unrealized securities losses due to a lack of appropriate interest rate hedging and a high proportion of uninsured deposits were particularly vulnerable to runs. The failure of Silicon Valley Bank highlighted the risk factors that other banks may also be facing. As of June 2024, aggregate unbooked securities losses for banks decreased to $513 billion from $516 billion in the first quarter of 2024. However, with rising interest rates, it is predicted that losses will increase further.
The vulnerability of banks to unrealized investment losses can be assessed through various tools, such as the U.S. Banks' Unrealized Losses on Investment Securities Screener, which analyzes over 1,000 U.S. banks with assets exceeding $1 billion to calculate their exposure to unrealized losses. This tool helps measure the financial health of banks by comparing unrealized losses to their equity. Additionally, the quarterly U.S. Banks' Unrealized Losses on Investment Securities Screener, produced by FAU's College of Business, offers insights into banks' exposure to risk based on their unrealized losses.
The potential impact of bank failures due to unrealized investment losses extends beyond individual institutions. The collapse of Silicon Valley Bank and other banks in 2023 sent shockwaves through the industry, and there are concerns about a domino effect leading to a credit crunch and slowing economic growth. A bank run on a vulnerable institution could trigger a broader panic, causing depositors to lose confidence in the banking system and potentially leading to a recession or financial crisis. Therefore, it is crucial for regulators to monitor these risks closely and take preventive measures to ensure the stability of the financial system.
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Overreliance on uninsured deposits
The collapse of Silicon Valley Bank in March 2023 has raised concerns about the stability of the banking sector. A report by the Social Science Research Network found that 186 banks in the United States are at risk of collapse due to rising interest rates and a high proportion of uninsured deposits. This report estimated the market value loss of individual banks' assets during the Federal Reserve's rate-increasing campaign. The study also examined the proportion of banks' funding that comes from uninsured depositors with accounts worth over $250,000.
The failure of Silicon Valley Bank has been attributed to its overreliance on uninsured deposits, with around 90% of its total domestic deposits being uninsured. This made the bank more vulnerable to a run on deposits, where depositors quickly withdraw their funds, leading to a liquidity crisis. If a large number of banks were to fail due to an overreliance on uninsured deposits, it could cause a domino effect, with other banks failing as well. This could lead to a credit crunch, making it difficult for businesses and consumers to access credit, and potentially resulting in a financial crisis.
Several other banks have also exhibited warning signs of potential failure, including Republic First Bank, which reported unrealized securities losses greater than its equity as early as June 2022. These losses have been exacerbated by rising interest rates, which have decreased the value of long-maturity securities. As a result, many banks have suffered significant losses, with unrealized securities losses reaching $478 billion. Additionally, more than 40 banks with over $1 billion in assets have reported unrealized security losses greater than 50% of their equity capital, and over 200 smaller banks are in a similar position.
To address the issue of overreliance on uninsured deposits, regulators and banks must take proactive measures. Regulators should implement targeted approaches that improve safety and soundness while avoiding adverse effects on credit availability. This includes discouraging banks from relying on unstable categories of uninsured deposits and ensuring that banks are prepared to use the Federal Reserve's discount window during periods of significant deposit outflows. Banks, on their part, need to make strategic decisions that reduce their exposure to volatile, short-term uninsured deposits and ensure better management and regulatory oversight to prevent liquidity crises.
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Rising interest rates
The impact of rising interest rates on banks was evident in the collapse of Silicon Valley Bank, Signature Bank, and First Republic Bank in 2023. These failures were attributed to a combination of factors, including unrealized investment losses and overreliance on uninsured deposits. The increase in interest rates led to a decline in the value of the banks' assets, and a significant number of uninsured depositors withdrew their funds, contributing to the banks' collapse.
To address these challenges, financial supervisors and regulators are enhancing their analytical tools and responses. The Federal Reserve Board of Governors' semiannual report on bank supervision and regulation highlights the resilience of the U.S. banking system, but also acknowledges the increased risks associated with credit, liquidity, and interest rates in 2023. Examiners are closely monitoring banks with significant underwater securities holdings and interest rate risk exposures, focusing on deposit trends, funding sources, and the value of investment securities. These efforts aim to identify vulnerabilities and ensure the stability of the banking system in a challenging economic environment.
While rising interest rates pose risks to banks, it is important to note that banks also benefit by collecting higher interest rates from borrowers. Additionally, the impact of rising interest rates on home prices and the broader economy is complex and influenced by various factors. Central banks play a crucial role in managing interest rates to curb inflation and maintain economic stability.
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Declining asset values
Banks are closing down due to a variety of factors, including declining asset values. The recent increase in interest rates by the Federal Reserve has increased the fragility of the US banking system, leading to a decline in the value of bank assets. This has been exacerbated by the high proportion of funding from uninsured deposits. When assets decline in value due to increased interest rates, banks may not have enough assets to pay off their debts and cover other business necessities, which can result in insolvency and closure.
The failure of Silicon Valley Bank in March 2023 has been cited as an example of the risks posed by rising interest rates and uninsured deposits. The bank's assets lost value due to rate increases, and the situation was worsened by withdrawals from uninsured depositors. As a result, the bank was unable to meet its obligations to its depositors and was forced to close.
A study by researchers at Columbia Business School found that US banks have lost about $2 trillion in aggregate in the value of their assets since the beginning of the Federal Reserve's tightening cycle. This decline has eroded capital buffers, making banks more vulnerable to adverse credit events. The study also highlighted that a significant number of CRE loans and office loans are in negative equity, with one-third of all CRE loans and the majority of office loans facing substantial refinancing challenges due to elevated interest rates.
The impact of declining asset values is particularly pronounced for smaller regional banks with high exposure to CRE loans and uninsured deposits. These banks are at a higher risk of failure due to the combined impact of asset value declines and CRE loan defaults. A report posted on the Social Science Research Network identified 186 banks in the United States that are at risk of failure due to rising interest rates and a high proportion of uninsured deposits. The report estimated that if half of the uninsured depositors withdrew their funds, even insured depositors may face impairments as the banks would not have enough assets to cover all liabilities.
The stability of the US banking system is crucial to the economy, and the potential impact of bank failures could be significant. Regulatory responses and government intervention may be necessary to prevent further bank failures and mitigate the risks posed by declining asset values and other economic pressures.
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Bank runs by uninsured depositors
Banks with a high proportion of uninsured deposits are at a higher risk of collapse. Uninsured deposits refer to deposits that exceed the Federal Deposit Insurance Corporation's (FDIC) insurance limits. In the US, this limit is $250,000, meaning that any amount over this is not insured and could be lost if the bank collapses.
A report by the Social Science Research Network found that 186 banks in the US are at risk of collapse due to rising interest rates and a high proportion of uninsured deposits. The report estimated the market value loss of individual banks' assets during the Federal Reserve's rate-increasing campaign and examined the proportion of banks' funding that comes from uninsured depositors with accounts worth over $250,000.
If a large number of these 186 banks were to fail, it could lead to a domino effect, causing other banks to collapse as well. This could result in a credit crunch, making it difficult for businesses and consumers to access credit and slowing economic growth. A bank run on one of these vulnerable institutions could also cause a ripple effect, leading to a broader panic and a loss of confidence in the banking system as a whole.
Several factors contribute to a bank's vulnerability to a run by uninsured depositors. Firstly, banks with a high ratio of uninsured deposits to total deposits are more at risk. If a bank reports a ratio greater than 50%, it is considered to be at an elevated risk of a run. Additionally, banks with lower tangible common equity ratios, adjusted for unrealized losses on holdings of securities, are more susceptible to runs. Banks with exposure to losses from commercial real estate and unrealized securities losses are also at an increased risk of a liquidity crisis caused by withdrawals from large uninsured depositors.
To mitigate the risk of bank runs by uninsured depositors, regulators need to thoroughly investigate and address the risks posed by excessive reliance on uninsured deposits. Banks should be required to provide disaggregated data on uninsured deposits to facilitate stability assessments. By understanding the nature of uninsured deposits, such as whether they are retail or wholesale and operational or non-operational, regulators can propose rules to limit a bank's use of unstable funding sources.
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Frequently asked questions
Yes. A report posted on the Social Science Research Network found that 186 banks in the United States are at risk of collapse due to rising interest rates and a high proportion of uninsured deposits. Hundreds of small and regional banks across the United States are feeling stressed.
Unrealized investment losses and overreliance on uninsured deposits are two major factors that can contribute to a bank's risk of collapse. A decline in the value of bank assets and a high share of funding from uninsured depositors are also warning signs.
If a bank collapses, it can lead to a domino effect, causing other banks to fail as well. This can result in a credit crunch, making it difficult for businesses and consumers to access credit, slowing economic growth, and potentially leading to a recession or financial crisis.
