Why Do Banks Fail?

What happened with the two recent bank failures in Silicon Valley?

Silicon Valley Bank and New York-based Signature Bank and looks like two others are having a “bank run.” A run on a bank happens when a sizable number of depositors withdraw their money from a bank(s) at the same time that is greater than the bank’s liquid assets. Consequently, causing a bank to close because it cannot meet its financial obligations to depositors and creditors. The closure can become permanent if the bank can’t raise capital and then becomes insolvent. Which means it no longer has enough liquid assets (money) to fulfill its payment commitments.

What happened?

Basically, a bank fails because of undercapitalization, not enough liquidity, management incompetence, and fraud. This gets out to the public, especially now in the social media age, which creates a frenzy due to its soundness. People are scared that they will lose their money in the bank. This happened many times throughout history, in the last 100-plus years there was the Stock Market Crash of 1929, the Savings and Loan Crisis of the 1980s and 1990s, and the Great Recession of 2008.

Between 2008 and 2015 over 500 banks failed. Recently because of COVID only four banks failed in 2020 and none failed in 2021.

Why now?

Currently, we have Stag Inflation and High-interest rates that create an economic disaster that leads to market recession and depression. This scares the customers who in turn make a “run” on the bank, pulling out their money out. (See the great movie, “It’s A Wonderful Life). Since customers are demanding their deposits, the bank has to unload its bond investments and pull from its reserves. If the reserves are less than the demand, well that is easy math. This is called, “cash confidence” or “liquidity crisis.” In the end, the bank as lost its cash and became essentially insolvent, then it is closed or taken over.

Why Silicon Valley and related banks?

The Silicon Valley banks were specializing in Venture Capital for tech startups. With record amounts of new tech companies, many of them failed and they were total losses. However, the banks had the reserves to weather those storms. So, most banks, especially the big ones are safe, as long as they have good competent management. Signature Bank deposits went from what was publicly documented from $60 billion in 2018 to $189 billion in 2022. That is amazing; however, they were paying out more in interest than what they were making. Thus, they are also being accused of gross mismanagement due to how they handled their reserves. Then, that news got out, and, people panicked.

A fun fact, a “bank reserve ratio” is $.10 per $1. Banks have 1 cent of reserves per dollar in accounts, a ratio of 100-1.

Although, the Fed recommends between 3% and 15%. In contrast, insurance companies by law must have reserves of 3 dollars for every 1 dollar of insurance written. This is why the bigger and smarter smaller banks put their safe investments at. In addition, insurance companies give the banks 6-12% while the banks give you less than 1%. This is called the “net interest margin.” This is why Banks that do not diversify go under and insurance companies have been around for 175 – 200 + years and do not go under.

Are some banks in danger of a run now?

Keep in mind the only banks that would be in danger now are if they are under-funded, have made bad investments, and have inept management. In addition to your traditional accounts are insured up to $250,000.

The Fed has been increasing the interest rates that make money less available and fewer people and companies are borrowing which means less income for banks. Because of the current economic times caused by government incompetence money is worth less and is hard to get.

People cannot obtain affordable mortgages or refinance, and business cannot purchase their inventory to bring to market. This means people do not have the resources to build, pay bills, invest, and hire workers. The results are simple. Money becomes scarce, prices go up and then banks do not have the income from loans coming in for their revenue sources. It is basic economics that anyone who took a college finance or economics class would know. Unfortunately, no one in the current Executive government or Fed has. We went through this in the late 70s and made all the same mistakes then as what is happening now. It seems that no one has learned the lessons. “Stupid is as stupid does.”

Then compounded further, some of the smaller banks like Silicon Valley Bank and others decided to take their reserves that are normally used to obtain money from the Federal Reserve for giving out loans and redirecting that to a “safe” investment of treasury bonds. Was a good idea at the time; however, inflation was not accounted for. Signature Bank invested too much into cryptocurrency deposits and made a big risky play that did not work.

Let’s look at the numbers.

Silicon Valley Bank and Signature Bank had to sell their bonds and cryptocurrency at a big loss.

The 1 Year Treasury Rate is relatively high at 4.90%, compared to 1.19% a year ago. However, the annual inflation rate for the United States is lowballed at 6.4% for the 12 months, according to U.S. Labor Department. Of course, if you paid a utility bill or bought gas or groceries you know that the actual rate is more than twice that. The banks bought These “safe” bond investments at between. 59% and 1.19%. Thus, the bonds the banks participated in last year were paying far less than bonds issued currently. Then, cryptocurrency went from $46,197.31 in December of 2018 to $16,600 today. In the last three months, it went from $23,646.55 to $16,625.08.

This current higher Treasury Rate looks good, but that reduced the value of the bank’s bonds then in turn affected its reserves in addition to inflation. Additionally, its securities investments had also fallen in value. That loss compounded with the lower rate of purchase is causing the banks to have fewer assets creating a liquidity crisis, thus triggering the Fed alarms.

Ironically, investing in the government’s future caused some of these banks to go under.

Meanwhile, the Executive branch has guaranteed the deposits of those bank deposits because they have their money, and the deposits are FDIC insured if it’s less than $250,000. Unfortunately, 85% of the two Silicon Valley banks’ despots are over that limit, which the Fed is not covering. Those depositors made some very bad financial decisions by not diversifying or protecting their money! Furthermore, the investors of the bank are looking at total losses and liability issues.

Why have the big banks not gone under if they do the same?

Bigger banks have bigger reserves and are usually better conservatively managed. And, all banks invest in bonds, usually, 20% of their reserves as is your 401k. Diversification is key. The rest of the bank assets are put in the stock market and invested in what never goes undervalued or losses money, those insurance trusts, life insurance (tax-free even for businesses), and stocks.

If you want to safeguard your money and build your wealth and invest in a safe way that builds your future; we can help you!\\

Dr. Richard J. Krejcir is a licensed and experienced Financial Consultant with over thirty years of experience. He has worked for major banks, insurance companies, nonprofits, and families too. He is also an author, pastor, and financial blogger and holds a doctorate in Stewardship.




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