The Trust Crisis Of Banks Worsens Ensuing Initial Collapse Of SVB. A Plus for Crypto
The US banking sector is facing a crisis of trust following
the collapse of Silicon Valley Bank, which has left many Americans,
particularly those without insurance for their deposits, anxiously
trying to determine if their money is safe. A recent report found
that more the 186 banks, or 5% of all banks in the country, are in
danger of failing. The article outlines the analysis, identifies the
risk factors to watch out for, and explains why investing in
cryptocurrency could be a genuine safe-haven option.
Source: SSRN Papers-Full Study
As
the above screenshot shows, the study is titled ‘Monetary Tightening
and US Bank Fragility in 2023; Mark-to-Market Losses and Uninsured
Depositor Runs?’ It was written by four academics from distinguished
universities in the United States on March 13th, 2023.
The
report begins with a brief explanation of why so many US banks are at
risk of going under and pertains to all the assets banks hold on their
balance sheets. These are US bonds (US government debt) and
mortgage-backed securities (MBS) (bundles of mortgages). US Bonds and
MBSs are the safest assets a bank can hold, at least according to
regulators, and why banks tend to invest most of their customers'
deposits in US bonds and MBSs.
Images sourced at Investopedia.com
These
assets earn interest for the banks and thus make it possible for them
to offer services with low or no fees. However, when interest rates
rise, the value of US bonds and MBSs decreases. The reasons for this are
many, but the main takeaway here is that higher interest rates result
in US bonds and MBSs crashing. If the value of these assets falls too
much, banks can become temporarily insolvent.
This
insolvency is temporary because when US bonds and MBSs mature, meaning
the loan terms end, the bank receives the total value of the underlying
asset. Again, the mechanics of this are many, but just know that US
bonds and MBSs don't lose money if they are held to maturity, and why
banks don't report the losses on US bonds and MBSs when interest rates
rise.
Most
information about losses on debt securities held by banks is immersed
in the glossaries in their SEC filings. It is not considered a
significant problem until that bank has major liquidity issues. It’s
because it's not a loss until they sell, and in the case of US bonds and
MBSs, they won't lose anything if they hold them to maturity.
This
accounting practice is arguably controversial. These so-called
unrealized losses are acceptable if the bank isn't forced to sell any of
these assets at a loss, specifically customer withdrawals. It’s what
happened to SVB and why it sank. However, there is one crucial detail to
keep in mind. 92.5% of SVB's deposits were uninsured by the Federal
Deposit Insurance Corporation (FDIC).
For
context, the FDIC only ensures bank deposits up to $250,000 per
account. Any amount above that is considered uninsured. SVB experienced a
bank run because its uninsured depositors could see that it had many
unrealized losses. This led to speculation that SVB didn't have enough
money to honor all withdrawals.
As
such, this bank run may not have happened if most deposits were
insured, i.e., under $250K per account. SVB had so many uninsured
deposits because the bank provided accounts and banking services
primarily to small and medium-sized businesses, startups, and entrepreneurs in Silicon Valley. These clients typically require lots of cash liquidity to pay their employees, make acquisitions, etc.
Around
$9 trillion of bank deposits in the United States are uninsured,
roughly 50% of all bank deposits. Banks have been happily investing
these uninsured deposits into US bonds and MBSs. The problem is that
interest rates have risen, and their unrealized losses have proliferated. At the end of 2022, US banks collectively had unrealized losses totaling more than $600 billion. Interest rates have risen more since then, so these losses are likely even more prominent now.
In
short, US Banks have lots of unrealized losses and also lots of
uninsured depositors who are concerned that banks can't honor
withdrawals because of these unrealized losses. The authors examined
over 4,000 banks in the study to see which ones were most at risk and
why.
Unrealized Losses
First, the study highlighted that 42%
of all bank deposits had been invested into regular MBSs, with another
24% invested in commercial MBSs, i.e., commercial real estate loans, US
bonds, and other asset-backed securities (ABS). The authors then tried
to calculate the unrealized losses on these assets. After crunching the
numbers, the authors found the following,
“The
median value of banks' unrealized losses is around 9% after marking to
market. The 5% of banks with worse unrealized losses experience asset
decline of around 20%.”
Note that ‘marked to market’
means ‘assuming sold today.’ In lay terms, the average American Bank
has unrealized losses of around 10%, and 5% of the most vulnerable banks
have unrealized losses of 20%.
So
if depositors were to rush and withdraw from these banks, they would
get 90% of their money back at the average bank and 80% back at a
vulnerable bank. Not surprisingly, these unrealized losses were the
smallest for Global Systemically Important Banks
(GSIB), including JPMorgan and Bank of America. GSIBs have less than 5%
of unrealized losses. The average non-GSIB has 10% unrealized losses,
and SVB wasn't even the worst.
The
authors found that more than 11% of US banks had larger unrealized
losses than SVB when it collapsed. They estimate that as many as 500
other banks could have failed based purely on unrealized losses. The
reason why only SVB went down was because of the high number of
uninsured deposits. The authors then provide a series of scenarios to
showcase how uninsured depositors could react to rising interest rates.
Uninsured Depositors Waking Up
The first scenario assumes
that the uninsured depositors stick around and wait. The other three
scenarios surmise they withdraw and invest in other assets, which
provides a higher interest rate than a savings account. Understand that
insolvency fears related to unrealized losses aren't the only reason why
uninsured depositors withdraw money from a bank.
The
primary reason why they would do this is that they want to earn a
high-interest rate on their large deposits. This desire for yield
increases as interest rates rise. Unfortunately for the banks, it's hard
for them to provide competitive interest rates on savings accounts
without losing lots of money. This is why many US banks haven't increased
their interest rates on savings accounts, despite interest rates
increasing. They’re making lots of money off their depositors. However,
if they were to raise interest rates on savings accounts, they wouldn't
make nearly as much money.
In
the study, the authors assume that most uninsured depositors are
sleepy, meaning they aren't rushing to withdraw to earn a higher
interest rate elsewhere. However, this is starting to change; besides
the banking crisis, the high-interest rates that are still rising in
other regions tempt those sleepy uninsured depositors into waking up and
moving their money elsewhere. If they do this, banks with large,
unrealized losses will start going under as they won't be able to honor
all withdrawals.
How Many Banks At Risk?
Naturally, the authors assess
whether banks have enough assets to honor these upcoming withdrawals
from uninsured depositors. They assume that the FDIC doesn't close down
banks that come under stress, which is significant because the FDIC is
likely to do this if banks start getting squeezed.
The
good news is that all bar two American banks have enough assets to
honor withdrawals from uninsured depositors. The bad news is that the
authors don't specify which two banks are at risk, but they conclude
that this little risk means additional bank runs are unlikely for the
time being.
For Good Measure
As an extra,
the authors analyzed the possibility of what would happen if uninsured
depositors ran. They did a number of simulations of bank runs, from 10%
to 100% of uninsured depositors withdrawing their assets.
Source: SSRN Papers-Full Study
What's concerning is that the ten banks most at risk of experiencing a bank run are large. As the authors cite in the study,
“The
risk of run does not only apply to smaller banks. Out of the 10 largest
insolvent banks, 1 has assets above $1 Trillion, 3 have assets above
$200 Billion (but less than $1 Trillion), 3 have assets above $100
Billion (but less than $200 Billion), and the remaining 3 have assets
greater than $50 Billion (but less than $100 Billion).”
Unfortunately,
the authors don't specify which banks these are but reveal how
sensitive US banks are to bank runs. They concluded that even if just
10% of uninsured depositors withdrew their money from banks, 66 banks
would go under. If 30% of uninsured depositors withdrew their money, 106
banks would go under. If half of all uninsured depositors ran, 186
banks would fail. This underscores that at least a few dozen banks are at risk of going under over the coming months.
This
is ultimately due to the fatal combination of significant unrealized
losses due to rising interest rates and withdrawals from uninsured
depositors seeking higher yields from these rates. The final simulation
was if 100% of uninsured deposits withdrew all their assets from US
banks. They insisted that this simulation is worth doing to assess the
state of the US banking sector. Surprisingly only about half of US banks
would go under.
The
authors then conclude by highlighting that the value of assets held by
US banks is more than $2 trillion lower than what's being reported,
thanks to unrealized losses-based accounting. They reiterate that
hundreds of banks are at risk of going under if uninsured depositors
withdraw. They warned that even small numbers of withdrawals from
uninsured depositors could lead to unrealized losses being realized.
This would lead to more bank runs, evolving into an even bigger banking
crisis than we've seen. They go as far as to suggest regulations to
address this.
For
starters, banks should start changing how they report their unrealized
losses so that bank depositors have a better sense of how underwater
their banks are. Because of the lack of transparency, the authors
manually calculated these unrealized losses using complex maths. The
authors acknowledge that this won't solve the insolvency risks many
banks face, so they recommend that banks be forced to increase their
capital requirements.
This coincides with what Michael Barr, the Fed’s Vice-chair for Supervision, has been busy doing. Michael had been examining capital requirements
for banks before the banking crisis began. Maybe he saw the banking
crisis coming or was preparing to take advantage of it to introduce
regulations. Michael Bar’s anti-crypto speech
indicates the second possibility is the most likely. Michael has been
desperate to increase his powers, presumably to consolidate the banking
sector to assist in the rollout of a central bank digital currency.
Be Vigilant of The Risk Elements
Which risk factors should you be aware of
when analyzing banks? I am not a financial adviser. Still, my research
into this convoluted accounting system revealed that the two main risk
factors are unrealized losses and uninsured deposits. It is at risk if
your bank has many unrealized losses and uninsured deposits. The problem
is that it takes work to estimate these unrealized losses. Moreover,
not all uninsured deposits are prone to flight. Remember that most of
them are required to pay employees at small companies.
Also,
as mentioned above, most banks with many uninsured deposits tend to be
smaller, i.e., not GSIBs. In theory, this makes them inherently riskier
than GSIBs. In practice, though, when a non-GSIB goes under, it gets
acquired by a GSIB. This means your assets could be safer at a small
bank. If you read the article about bank bail-ins, you'll know that GSIBs can be risky.
If
a non-GSIB goes under, it gets acquired by a big bank, and customer
deposits are kept, but if a GSIB goes under, customer deposits are used
to bail them out. As recently happened with Credit Suisse and its
takeover by UBS. The arguably political deal required capital from
somewhere to satisfy UBS. According to WSJ, the Swiss government was desperate to avoid the appearance that this was a taxpayer-funded bailout.
GSIBs are also more likely to comply with investment ideologies, like ESG. As discussed in this article,
the Bank of America is one of the big institutions behind the ESG
movement. Some of its affiliates are introducing individual ESG scores
for their customers.
Small
banks may also have challenges because around 80% of commercial real
estate loans come from small banks. In addition to being wrecked by
higher interest rates, commercial real estate is struggling because
people must return to the office. 50% of office spaces
in the US are empty. This means that small banks are at a higher risk
of sitting on larger unrealized losses, which is consistent with the
findings of the study.
If
that weren't bad enough, these losses would likely increase as time
passes, even if interest rates start coming down because work from home
is probably here to stay. Even if uninsured depositors are less likely
to withdraw from small banks due to the purpose of these deposits, just a
small number of withdrawals could therefore cause severe issues for
small banks.
The
findings of the study suggest this risk is already there. All it takes
is 10% of uninsured deposits to move. In sum, small and big banks come
with their own risks, and it's up to you to decide which risks you'd
instead take. Diversifying your deposits is an option, but the fact that
every bank operates using this fractional reserve model means your
money will never be genuinely risk-free in their coffers.
Image credit: Markethive.com
Cryptocurrency To The Rescue
This is where cryptocurrency comes in.
Cryptocurrencies ostensibly have only one risk: their current price
volatility. There are, of course, risks associated with things like
improperly written code, but the largest and most established
cryptocurrencies have been battle tested every day for over a decade.
Aside
from that, cryptocurrencies are one of the best hedges against the
banking system. When you hold a cryptocurrency, there is no counterparty
risk. That crypto is genuinely yours, and there isn't some greedy
banker going and investing your crypto into a basket of risky,
commercial real estate loans behind your back.
This
characteristic alone makes cryptocurrency valuable. Also,
cryptocurrency lets you send a transaction to whoever you want, whenever
you want, and for however much you want. This is the true definition of
financial freedom, and its importance was fully displayed when Nasdaq halted the trading of bank stocks during the recent banking crisis.
Nobody
can turn off the decentralized cryptocurrency exchange and prevent
people from trading. You will always be able to trade. Take a second to
consider; that blocking transactions, halting trading, and freezing
assets will only become more common as CBDCs are rolled out.
This will make the financial freedom aspect of cryptocurrency ever more
critical, along with the decentralization that underlies it.
Without
decentralization, crypto's value proposition quickly disappears. That's
why instead of wasting time assessing the unrealized losses and
uninsured deposits of banks, you should learn about what makes a cryptocurrency genuinely decentralized.
After all, the days of commercial banks are numbered; the thousands of
existing banks will inevitably consolidate into a handful of mega banks,
and governments will nationalize these mega banks.
Financial
freedom in the traditional financial system will be gone when that
happens. At the same time, economic freedom in the crypto ecosystem will
only continue to grow. By the grace of God, it will rise to the point
that it's capable of accommodating the billions of people who will pull
out of the traditional financial system as it becomes ever more
centralized and ideological.
Both
monetary mechanisms will take years to play out, but it's already clear
that the global financial system is splitting into two structures: free
and sovereign and one that is not. You now have the
once-in-a-millennium opportunity to choose which system to participate
in. It’s critical to make that decision before it's made for you.
This
article is provided for informational purposes only. It is not offered
or intended to be used as legal, tax, investment, financial, or other
advice.
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Editor and Chief Markethive:
Deb Williams.
(Australia) I thrive on progress and champion freedom of speech. I
embrace "Change" with a passion, and my purpose in life is to enlighten
people to accept and move forward with enthusiasm. Find me at my
Markethive Profile Page | My
Twitter Account | and my
LinkedIn Profile.
Also published @ Substack.com; BeforeIt’sNews.com; Steemit.com.
The Trust Crisis Of Banks Worsens Ensuing Initial Collapse Of SVB. A Plus for Crypto: The Trust Crisis Of Banks Worsens Ensuing Initial Collapse Of SVB. A Plus for Crypto ...
