Are bank failures back?
The collapse of Silicon Valley Bank roiled markets late last week. Is this a one-off, or will there be contagion to follow?
It is a complicated question. Many have warned of financial risk in the markets and interest rate hikes have been tough on many banks.
Regulators shut down Silicon Valley Bank on Friday, which was the largest bank failure since 2008, following the Federal Reserve’s decision to hike interest rates by 1,700% in less than a year. As a result, investors began to withdraw their money, and the bank was forced to sell its loan portfolio at a substantial loss.
This incident demonstrates that the Fed’s aggressive interest rate regime can destabilize formerly stable institutions. Additionally, there have been two recent high-profile examples of the impact of higher rates: the cryptocurrency market collapse and the double-digit decline in high-growth tech stocks.
The collapse of Silicon Valley Bank is a prime example of the dislocations that are exposed when rate cycles shift. Investors should be particularly concerned about commercial real estate, with over $60 billion in fixed-rate loans requiring refinancing at higher interest rates, and more than $140 billion in floating-rate commercial mortgage-backed securities maturing in the next two years.
SVB may not be the only bank facing significant losses on its bond portfolio as interest rates rise, indicating a potentially ominous situation. As investors become aware of these risks, they may turn their focus to the next vulnerable bank facing interest and credit risks, creating a ripple effect.
Banks can fail for various reasons, including poor management, high levels of bad loans or risky investments, fraud, and economic downturns or crises. When a bank fails, it means that it is unable to meet its obligations to depositors and creditors, such as paying out customer deposits or repaying loans. This can lead to a run on the bank, where depositors rush to withdraw their funds, which can further exacerbate the bank’s financial problems.
In some cases, the government may intervene to bail out or rescue failing banks to prevent a wider economic crisis or financial panic. However, in other cases, banks may be allowed to fail, which can result in significant losses for depositors and investors.
To prevent bank failures, regulatory bodies and central banks typically have oversight and supervisory roles to ensure that banks are operating prudently and have adequate capital buffers to absorb potential losses. Banks themselves also have risk management and compliance frameworks to monitor and mitigate potential risks.
Let’s take a walk down memory lane to remember what happened back in the housing crash of 2008. It was caused by a complex set of factors, but some of the key reasons why many banks failed include:
- Subprime mortgage crisis: Many banks had invested heavily in mortgage-backed securities that were tied to high-risk subprime mortgages. When the U.S. housing market collapsed, the value of these securities plummeted, causing significant losses for banks.
- Excessive risk-taking: Some banks engaged in risky lending practices, such as making loans to borrowers with poor credit histories or investing in complex financial instruments that they did not fully understand.
- High levels of debt and leverage: Many banks had taken on significant amounts of debt and were highly leveraged, meaning that they had borrowed large sums of money to finance their operations. When the value of their assets declined, they were unable to repay their debts.
- Interconnectedness of financial institutions: The failure of one bank or financial institution had ripple effects throughout the financial system, as other institutions that were connected to it through various financial products or contracts also suffered losses.
The fallout had a profound impact on the global economy, leading to widespread job losses, foreclosures, and economic hardship.
Are we headed right back there again? Stay tuned.
In the mean time, you might be thinking it would be good to have some tangible assets within arm’s reach during times of economic uncertainty. 90,000 Lear customers would agree with you. Depositors at Silicon Valley Bank just went through several days of not having access to their funds. It’s a tough position to be in. Give us a call to discuss opportunities in precious metals.