Will more U.S. banks fail this year? The quick answer is “yes.” How many more? Perhaps more than any year during or after the 2008-2009 Financial Crisis, according to one study.
Bank failures happen more frequently than you think. Since 1776, the first year there was not a U.S. bank failure was 2005. There were 563 bank failures from 2001 through 2023. More than half of those occurred during and in the immediate aftermath of the Financial Crisis.
Until recently, however, there had been a drought of bank failures. Until the March 10, 2023 collapse of Silicon Valley Bank (SVB), no U.S. bank failures had occurred for 867 days. SVB unraveled in days after a staggering run on its deposits. Before SVB, the last time an FDIC-backed bank failed was October 23, 2020, when Almena State Bank failed. (Weeks before the SVB closure, Silvergate Bank announced its plan to undergo liquidation procedures, but has yet to be unwound.)
The largest U.S. bank failure in history was Washington Mutual, which had assets of $307 billion when it closed in 2008. SVB was the second biggest bank failure with about $200 billion of assets.
Then Signature Bank became the third biggest U.S. bank failure in history with $110 billion of assets. On Sunday, March 12, 2023, the bank closed its doors abruptly after regulators declared that keeping it open could threaten the financial system’s stability.
Overseas, the Swiss government rescued the failed Credit Suisse, a global investment bank and financial services firm founded in Switzerland. It is not uncommon for a few banks to shutter every year, but these are giant banks. Credit Suisse had a half-trillion-dollar balance sheet. The end of Credit Suisse’s nearly 170 years of operations is a significant moment in the banking world. Unlike Silicon Valley Bank, whose clients were concentrated in geography and industry, Credit Suisse is a global entity. The risk of additional bank failures increases when there is interconnectedness.
According to a March 13, 2023 study published in the Social Science Research Network (SSRN), “there are 186 banks with a negative insured deposit coverage ratio. In other words, for these banks comprising about $300 billion of insured deposits, even insured deposits would be impaired … Our calculations suggest these banks are certainly at a potential risk of a run, absent other government intervention or recapitalization.”
Eight days after the SSRN publication, the Federal Reserve announced coordinated international central bank action to improve liquidity. The tool used in this effort is called a “swap line.” A swap line is an agreement between two central banks to exchange currencies. Of course, these lines were already open. The enhancement is that, through the end of April 2023, the lines will be open daily instead of weekly. However, it could be too late if international banks get to the point where they need daily liquidity. Additionally, those smaller banks indicated in the SSRN paper could play a more significant role in increasing the odds of a recession.
The 25 largest U.S. banks are responsible for a lot of banking activity and are closer to that “too big to fail” level where they might receive a government bailout. Other banks may not receive that lifeline, which puts the economy in danger because those smaller banks account for 38 percent of all outstanding loans.
Given the stress in mid- and small-sized banks, similar institutions are expected to become more cautious in lending. Access to capital is the lifeblood of corporate investment and growth. Also, smaller banks will shore up their balance sheet and be less generous in providing loans to individuals to purchase houses, cars, or appliances. With funding drying up, the chance of a recession in 2023 increases.
Tighter capital controls from smaller banks may trigger a recession, but it’s better than the alternative: another financial crisis. I’ve been asked if this is the start of another 2008-2009-like crisis. I don’t think so. I could list all the reasons why not. For example, the median bank account balance is about $5,000 (the average is about $10,000). If a bank fails, most people will be just fine as they are under the $250,000-per-person FDIC insurance limit. And the Federal Reserve’s stress tests of large institutions “show that banks continue to have strong capital levels.”
But then, someone else could easily list all the reasons why Financial Crisis 2.0 is right around the corner. When analyzing the arguments, I found it helpful to reframe the hazards so that I could consider the risk less emotionally. As humans, we tend to focus on the danger right in front of us. And once we consider the possibility of peril, it sometimes seems like the only outcome.
Driving is an everyday occurrence that we perform with little thought. However, it’s probably the riskiest thing you’ll do today. You take a greater risk driving to the bank than putting your money in it.
When we are in the ocean, we feel exposed to a shark attack. But we’re 70,000 times more likely to be killed by a mosquito than a shark. I’m not downplaying the banking uncertainty; I’m suggesting that a financial crisis feels more probable when you are swimming in those banking waters.
Still, when I’m in the ocean, I am cautious of riptides and jellyfish. I’m worried that the Federal Reserve will pull me under and sting me. Last week the Fed raised the federal funds rate another 0.25 percent. The recent collapse of three giant banks (Silicon Valley, Signature, and Credit Suisse) could create at least the equivalent of as much monetary tightening. Also, consider that two of those banks failed due to runs triggered by unrealized losses in Treasury holdings. The rate hike was risky. To acknowledge the possibility of decreased liquidity due to bank closures, I am considering hedging my investment portfolios a bit more.
Allen Harris is the owner of Berkshire Money Management in Dalton, Mass., managing more than $700 million of investments. Unless specifically identified as original research or data gathering, some or all of the data cited is attributable to third-party sources. Unless stated otherwise, any mention of specific securities or investments is for illustrative purposes only. Advisor’s clients may or may not hold the securities discussed in their portfolios. Advisor makes no representations that any of the securities discussed have been or will be profitable. Full disclosures here. Direct inquiries to Allen at AHarris@BerkshireMM.com.
