US banks under pressure. What is going on?

The US banking sector is under pressure following the collapse of various banks. But this is not the same as what happened in 2008, and the UK banking sector is more stable.

When Silicon Valley Bank (SVB) failed on 10 March 2023 with $209bn in assets it became the second largest failure of a bank covered by the Federal Deposit Insurance Corporation (FDIC). 

It replaced Continental Illinios National Bank and Trust which had held that title since 1984. 

Just seven weeks later it has itself been replaced by First Republic Bank (FRB), which failed on 1 May with $229bn of assets. 

This has led to much soul searching and speculation: Is 2008 repeating itself? How has this been able to happen again? Is my money safe? 

Back to basics

The modern bank is an incredibly (probably indescribably) complex organisation. The largest employ hundreds and thousands of people across the world, and I doubt that any single employee (CEOs included) could name every type of financial instrument held on their employer’s balance sheets.  

But, if we strip things back, a bank is just that – a balance sheet. It borrows money from households and businesses with savings and lends it to households and businesses who want to borrow. Its borrowings (liabilities) are typically deposits and its assets are the loans it makes to other people. 

A bank makes its money by charging more interest to people it lends money to (on its assets) than it pays to those it borrows from (its depositors). 

How does this go wrong?

Most people will know the common truth about banking – if everyone rushes to pull their money out all at once, the bank won’t have it and what you have is a classic bank run. 

While this might seem like a bug, it actually underlies the key economic and social role of a modern bank. 

Through the process of maturity transformation, a bank can essentially give its depositors and borrowers what they want at the same time – depositors have (mostly) instant access to their savings and borrowers have access to funds over the long term. 

The other way for a bank to get into trouble is by losing money on the money it lends. If these losses become big enough, then eventually its assets will be less than its liabilities and it will be insolvent.  

2008 all over again?

As my colleagues Charles Davey and David Lock have written here - UK Banking in 2023, our view is that this time is different. 

In 2008, there were fundamental concerns that the whole banking system had become insolvent because of losses experienced on mortgage lending. More to the point, nobody really knew which bank was solvent or insolvent because nobody knew what their assets were worth. 

This time round what we are seeing is closer to a classic bank run. In the cases of Credit Suisse, Silicone Valley Bank, Signature Bank and now First Republic Bank the primary cause of their failures was customers withdrawing their deposits. 

Between 31 December 2022 and 31 March 2023, FRB suffered a 40% (or $70bn) decline in its deposits, and it was this announcement on 24 April which ultimately set in motion the wheels of its demise. 

FRB had only been able to repay these deposits by borrowing money from the Federal Reserve at high rates of interest, and so the FDIC took the decision that it was better to try and find a buyer to rescue it now than to let this continue and risk an even greater outflow of deposits, and therefore a more chaotic collapse later down the line. 

Why is this different?

Bank runs present a serious risk for any individual bank. However, they typically don’t present a risk to the whole system. This is because the money withdrawn has to go somewhere, and the vast majority ends up in deposits with other banks. 

It is also worth noting that the US market is different from the UK market in terms of fragmentation. 

There are more than 4,000 banks insured by the FDIC in the US, whereas there are 357 covered by the UK equivalent (the FSCS). 

This makes one bank for every 190,000 people in the UK, compared with one for every 70,000 people in the US. 

As such, US banks are more prone to failure, given the wider range of alternative options available to depositors. Indeed 75 banks have failed in the US in the last 10 years. In contrast, the UK market is more concentrated, giving it a greater degree of stability. 

That isn’t necessarily to say that the UK market is ‘safer’ – any bank can suffer a run and concentration means that any one bank failure in the UK would likely have a greater impact. But it does potentially explain why we are not seeing the same issues in the UK right now.

What next? 

Sadly, I doubt we have seen the end of this period of turbulence. It’s highly likely that we’ll see more bank failures, particularly in the US. 

The good news though is that the current banking crisis seems to have had a relatively limited impact on the wider economy so far. 

Our conversations with lenders suggest that many of them are still looking to grow their loan books and to support UK businesses. However, this doesn’t apply to every bank and so it might take more effort to navigate the market and find the right lender for your business. 

Update

At the time of publishing, stories are emerging of another US bank, PacWest, facing difficulties. Early suggestions from PacWest itself are that it is seeking a buyer as part of a review of its options rather than being in any particular trouble. 

However, this is clearly a fast-changing situation and so we may well be penning another article very soon. 

Further information

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