March 25, 2023 / VOLUME NO. 254

The Contagion of Fear

In my 36 years covering the U.S. banking industry, I have witnessed and written about three banking crises. The first occurred from 1988 to 1991, when over 1,400 financial institutions failed — including 531 in 1989 alone — according to data maintained by the Federal Reserve Bank of St. Louis. The primary culprit was the collapse of the commercial real estate market after many banks had underwritten an orgy of speculative development.

The second occurred during the 2007-08 financial crisis, when the subprime mortgage market imploded with global ramifications. Many fewer banks failed that time — just 137 in 2009 and 155 in 2010 — thanks to a massive bailout by the federal government. 

The spark of the most recent crisis (if it can be called that) occurred two weeks ago when banking regulators put just two banks of consequence into receivership – SVB Financial Group’s Silicon Valley Bank and Signature Bank. But the most recent episode was scary in a way that the first two weren’t. 

Those earlier crises were mostly about asset quality and capital, as the failed banks were largely the victims of their own bad loans. Silicon Valley Bank and Signature failed because their “loyal” customers panicked and withdrew billions of dollars in deposits at the lightning-fast speed of technology, which was like a knife slash to their jugular veins. Each bank was reasonably well capitalized, had acceptable asset quality and was profitable based on the year-end 2022 results — but none of that mattered. 

The failure of Silicon Valley Bank and Signature reaffirmed something we already knew. A bank can manage its way through a severe asset quality problem if it can raise fresh capital by persuading investors that the situation is salvageable. Death by loan loss can be slow and painful, while a liquidity run can be immediately fatal.

Both banks were uniquely vulnerable to a deposit run because of the composition of their funding. Both Silicon Valley Bank and Signature had sizable deposit shares above the $250,000 insurance limit. Neither was representative of most U.S. banks; and yet for days there was palpable fear that the industry might be gripped by a widespread liquidity crisis — so much so that the Federal Reserve had to step in by creating an emergency source of liquidity for banks, the Bank Term Funding Program. After determining a systemic risk exception, the Federal Deposit Insurance Corp. was able to offer unlimited insurance for depositors of the banks that failed, paid for with a special assessment on banks. 

Investors are spooked, with the KBW Nasdaq Bank Index down year-to-date about 23% at midweek. The larger, more important question is what depositors will do in the weeks ahead.

There is no rational reason why the failure of two such outliers as Silicon Valley Bank and Signature should pose a systemic liquidity threat to an entire industry, but fear is a contagion that does not respond to reason. In his first inaugural address, with the nation firmly in the clutches of the Great Depression, President Franklin D. Roosevelt said famously “the only thing we have to fear is fear itself.” 

I don’t think we’re facing that kind of cataclysm by any means, but Roosevelt’s statement about fear is as true today as it was in 1933.

• Jack Milligan, editor-at-large for Bank Director

* This newsletter was last updated at 5 p.m. EDT Thursday.

Community Bankers Emphasize Calmness, Stability Amid Crisis 

After Silicon Valley Bank and Signature Bank failed, community bankers highlight communication with their boards, clients and frontline staff. 

“This is a time for calm. We're not looking to create or exacerbate a problem.”

– Julieann Thurlow, Reading Cooperative Bank 

• Laura Alix, director of research for Bank Director

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