HomeFinanceAfter two significant bank failures in the United States, here’s what steps...

After two significant bank failures in the United States, here’s what steps to be taken next

After experiencing a bank run, two major banks that provide services to the technology industry have failed, leading government agencies to implement emergency measures to provide support to the financial system. In addition, President Joe Biden is attempting to alleviate concerns among Americans by assuring them that their bank deposits are secure.

The present situation is reminiscent of the financial crisis that began when the housing bubble burst about 15 years ago. However, the current events are unfolding at an even quicker pace than the previous crisis.

In the past three days, the United States government took control of the two financial institutions due to a bank run on Silicon Valley Bank, which is located in Santa Clara, California. This represents the most significant bank failure since the collapse of Washington Mutual in 2008.

WHY DID SILICON VALLEY BANK FAIL?

Silicon Valley Bank had already been negatively affected by a challenging period for technology firms in recent months, and the Federal Reserve’s decision to implement a forceful strategy of raising interest rates to address inflation further exacerbated the bank’s issues.

Like most banks, Silicon Valley Bank held several billion dollars’ worth of Treasuries and other bonds, which are generally viewed as secure investments. Nevertheless, the value of the bonds previously issued by the bank has started to decline due to their lower interest rates in comparison to the bonds issued during the current period of higher interest rates.

Typically, this situation would not cause problems as bonds are regarded as long-term investments, and banks are not obligated to recognize the decline in their value until they are sold. Banks generally do not sell these bonds at a loss except in dire circumstances when they require cash urgently.

Silicon Valley Bank, which collapsed on Friday, faced an emergency situation because its customers, primarily consisting of start-ups and technology-focused businesses, required more cash in the previous year, leading to a rise in withdrawals of their deposits. As a result, the bank was forced to sell a significant portion of its bonds at a significant loss. Furthermore, as news of the bank’s troubles spread, the rate of withdrawals increased, ultimately resulting in the bank becoming insolvent.

WHAT DID THE GOVERNMENT DO SUNDAY?

The Federal Reserve, the United States Treasury Department, and the Federal Deposit Insurance Corporation jointly agreed to ensure all deposits held at Silicon Valley Bank and New York’s Signature Bank, which was taken over on Sunday. It is worth noting that they made the critical decision to guarantee all deposits, surpassing the limit of insured deposits amounting to $250,000.

Numerous start-up technology customers and venture capitalists associated with Silicon Valley Bank had deposited amounts exceeding $250,000 at the bank. Consequently, as much as 90% of the bank’s deposits were not covered by insurance. Without the government’s decision to backstop all deposits, many businesses would have lost the money necessary to fulfill payroll, clear bills, and maintain operations.

The aim of extending the guarantees is to prevent bank runs, which occur when customers hurriedly withdraw their money from banks. By demonstrating the Federal Reserve’s commitment to safeguarding the deposits of individuals and businesses, the objective is to pacify people’s anxiety following a tumultuous few days.

Banks will be permitted to obtain loans directly from the Federal Reserve to manage any potential increase in customer withdrawals, without having to resort to bond sales, which might result in losses and jeopardize their financial stability. Silicon Valley Bank’s downfall was triggered by such fire sales.

Assuming everything progresses as intended, the emergency lending program may not need to lend a substantial sum of money. Instead, it will give the public confidence that the Federal Reserve will secure their deposits and is prepared to lend significantly to achieve this objective. Banks are not subject to any limits on the amount they can borrow, apart from their capacity to supply collateral.

HOW DID THE BANKS END UP WITH SUCH BIG LOSSES?

Ironically, a substantial portion of the $620 billion in unrealized losses can be attributed to the Federal Reserve’s interest rate policies over the previous year.

To curb the economy and reduce inflation, the Fed has rapidly raised its benchmark interest rate from almost zero to approximately 4.6%. This has resulted in an indirect increase in the yield, or interest paid, on various government bonds, particularly two-year Treasuries, which were above 5% until the end of the previous week.

Banks are not required to acknowledge the losses on their books until they sell those assets, and Silicon Valley Bank was forced to sell its assets. This was due to the fact that when new bonds with higher interest rates become available, existing bonds with lower yields become much less valuable if they must be sold.

HOW IMPORTANT ARE THE GOVERNMENT GUARANTEES?

The guarantees provided by the Federal Reserve, the U.S. Treasury Department, and Federal Deposit Insurance Corporation are crucial because legally the FDIC must follow the cheapest course of action when closing a bank. This would have meant that only the first $250,000 in depositors’ accounts would have been protected in the case of Silicon Valley or Signature if the government had not intervened.

The decision to exceed the $250,000 cap on deposit insurance required a determination that the failure of the two banks would pose a “systemic risk”. The Fed’s board, consisting of six members, came to this conclusion unanimously, and the FDIC and Treasury Secretary also agreed with the decision.

WILL THESE PROGRAMS SPEND TAXPAYER DOLLARS?

The U.S. government claims that the guarantee on deposits won’t have to rely on taxpayer funds, but instead, any losses from the FDIC’s insurance fund would be covered by an additional fee levied on banks. However, according to Krishna Guha, an analyst with Evercore ISI, political opponents may argue that the increased FDIC fees would ultimately be borne by small banks and Main Street businesses, potentially resulting in higher costs for consumers and businesses in the future.

WILL IT ALL WORK?

According to Guha and other analysts, the government’s reaction is far-reaching and should stabilize the banking sector, but the stock prices of medium-sized banks like Silicon Valley and Signature plummeted on Monday.

“We think the double-barreled bazooka should be enough to quell potential runs at other regional banks and restore relative stability in the days ahead,” Guha wrote in a note to clients.

According to economist Paul Ashworth at Capital Economics, the lending program offered by the Fed should enable banks to withstand the difficult situation.

“These are strong moves,” he said.

Yet Ashworth also added: “Rationally, this should be enough to stop any contagion from spreading and taking down more banks … but contagion has always been more about irrational fear, so we would stress that there is no guarantee this will work.”

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