Number theory: Understanding the new American banking crisis - Hindustan Times
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Number theory: Understanding the new American banking crisis

Mar 27, 2023 01:50 PM IST

A latest study published to the Social Science Research Network on March 13 estimated that the individual US banks' assets have lost an average of 10% of their market value during the Fed's rapid rate-hike campaign, with the bottom fifth percentile experiencing a decline of about 20%.

After hiking the benchmark interest rate, US Federal Reserve chairman Jerome Powell signalled that they were on the verge of pausing further rate hikes to limit its impact on the ongoing financial turmoil in the banking industry. "It could easily have a significant macroeconomic effect and we would factor that into our policies," he said in a Reuters article on March 22. How prevalent are banking failures in the United States? How serious is the current turmoil? What are its implications? Here are five charts that explain this in detail.

A security guard stands outside of the entrance of the Silicon Valley Bank headquarters in Santa Clara, California, U.S.(REUTERS) PREMIUM
A security guard stands outside of the entrance of the Silicon Valley Bank headquarters in Santa Clara, California, U.S.(REUTERS)

1. Bank failures have become a rather common phenomenon in America

Latest data from the Federal Deposit Insurance Corporation (FDIC) shows that 563 banks have collapsed in the US since 2000, meaning that an average of 25 US banks failed each year. The largest number of bank failures took place during the 2008 global financial crisis and its aftermath (389 banks between 2008 and 2011). Bank failures vanished the pandemic years of 2021 and 2022. In such a scenario, the collapse of the Silicon Valley Bank (SVB) on March 30 and the Signature Bank on shock waves across the banking sector.

"Such a long time without news of a bank collapse may have lulled depositors into a false sense of security. Without a reminder that banks can and do fail, depositors got caught up in a euphoria that touched a host of asset classes during the period, from tech stocks to digital currencies to long-dated bonds. Bank customers channelled billions of dollars into uninsured deposits," said Marc Rubinstein, a former hedge fund manager, in a Bloomberg opinion piece on March 13.

American bank failures and their total assets since 2000.
American bank failures and their total assets since 2000.

2. So, why did Silicon Valley Bank fail?

Rising borrowing costs in the US for more than a year eroded the value of bonds held by SVB, ultimately leading to a scenario where it could no longer liquidate its assets to pay for its depositors/liabilities. To be sure, the phenomenon of rising interest rates normally wouldn't be an issue- SVB would wait for the bonds to mature-but because there has been a slowdown in venture capital and tech broadly deposit inflows slowed and clients started withdrawing their money causing a run on banks.

A latest study published to the Social Science Research Network on March 13 estimated that the individual US banks' assets have lost an average of 10% of their market value during the Fed's rapid rate-hike campaign, with the bottom fifth percentile experiencing a decline of about 20%.

Benchmark interest rates in the US (in %).
Benchmark interest rates in the US (in %).

3. 186 American banks may be prone to similar risks as SVB

The aforementioned paper also finds that another 185 US banks are prone to similar risks as SVB even if only half of the uninsured depositors decide to withdrew, FDIC insures deposits up to $250,000, rest are uninsured. Moreover their total unrealised loss-the difference between what the banks originally paid for their bonds, and what they now could sell them for - in the US banking system was estimated to be $1.7 to $2 trillion which is little lower than the available capital buffer $2.2 trillion. This means if banks were forced to liquidate all their assets right now, the losses would erase anywhere between 77% and 90% of their combined capital cushion, further highlighting the fragility of the US banking system.

Movement in S&P 500 Index.
Movement in S&P 500 Index.

4. Why is the current crisis different from the one in 2008?

Unlike the failure of Lehman Brothers in 2008, the collapse of SVB and Signature Bank stems from the fact that both were extremely concentrated in their businesses - SVB largely catered to tech sector, while Signature catered to crypto. Data from the US Federal Reserve also shows that the valuation of the SVB ($209 billion) and Signature Bank ($110 billion) were below $1 trillion, as of December 2022.

Asset size of SVB and Signature vs the top 10 big banks in the US ( billions).
Asset size of SVB and Signature vs the top 10 big banks in the US ( billions).

5. Mid-size and small US banks account for a large proportion of lending in the US

Small- and medium-sized banks play a crucial role in driving credit growth in the US economy. A March 16 report by Goldman Sachs economists Manuel Abecasis and David Mericle said that lenders with less than $250 billion in assets account for roughly 50% of US commercial and industrial lending, 60% of residential real estate lending, 80% of commercial real estate lending and 45% of consumer lending.

The immediate impact of the ongoing banking stress will make these banks to tighten their lending standards more, denting economic growth and raising the risk of a recession.

Shares of loans held by small domestic banks.
Shares of loans held by small domestic banks.
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  • ABOUT THE AUTHOR
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    Pavitra Kanagaraj is a data journalist. She uses public and private datasets to cover economy, women, and politics. Prior to HT, she did macroeconomic research at UNESCAP and ERF. She co-founded the Rethinking Economics chapter at JNU in 2021.

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