We are still at the beginning of a banking crisis. It started in early March when Silicon Valley Bank
(SVB) collapsed and was taken over by FDIC. Shortly thereafter, Signature Bank went under. First
Republic Bank (FRB) lasted for a few more weeks before it was auctioned off to JP Morgan Chase.
PacWest Bancorp is the latest under pressure (although it seems to be improving recently).
Federal bank regulations allow banks to classify their bond investments according to if they plan to
hold them to maturity or sell them prior to maturity. If the bank plans to hold them to maturity, then
the bonds are priced at par value, regardless of the current market price. If a bank needs to sell a
portion of these bonds at a loss to cover redemptions, the bank may no longer meet their regulatory
capital ratio requirements. This would require the bank to look for additional capital, which may raise
the suspicion of additional bank clients which would further the run on the bank, causing more losses
as additional bonds would need to be sold…as happened at SVB, Signature and FRB.
U.S. banks are in a pickle. Since 2009, banks have had to invest client deposit at extremely low
interest rates. Now that the Federal Reserve has raised rates so quickly, banks are sitting on large
losses if they have to sell these investments. These large losses are also preventing banks from raising
the interest rates that they pay clients on deposits, causing clients to move their money out of banks
to other investments that pay current interest rates of 4%+.
As clients pull money away from traditional banks, that is removing capital that could be loaned
out to businesses to drive the economy forward. This is not a short-term problem. The bank’s
investments are mostly long-dated bonds that mature over the next 20 years.
The Federal Reserve and banking regulators are assuring the public that the banking crisis is over.
They have taken extraordinary measures to give banks access to cash to stem the short-term pressure
of client withdrawals, but this is a long game. We will be living with this undercurrent until interest
rates fall or the bonds that the banks are carrying reach maturity.