Lerner Profs Discuss Fallout of Banking Crisis

Until March, most people watching the economy were bemoaning the woes of inflation and debating signs of a possible recession. Now, we’ve got banks to worry about too.

Silicon Valley Bank (SVB) in Santa Clara, California collapsed on March 10 as tech businesses, alarmed by weaknesses in the bank’s finances, took their deposits and ran. This was followed closely by the demise of Silvergate Bank and New York’s Signature Bank. Their fates were tied to their reliance on cryptocurrency and a similar run on the bank by depositors. Despite having company, Silicon Valley Bank got stuck as the face of the panic.

Financial analysts and reporters seemingly talked about little else for weeks. And now it’s happened again, as First Republic Bank in San Francisco failed on May 1 and more may be coming. JP Morgan Chase came to the rescue (and got bigger at the same time by acquiring First Republic’s assets).

First Republic’s fall “spells the end of what was considered one of the most successful strategies in banking: luring wealthy depositors and giving them five-star service,” the Wall Street Journal wrote.

The average person may care more about gas prices or rent than the fate of banks in California that made and lost their billions catering to the wealthy. But as one bank after another teeters, then topples, the unease can creep, leaving consumers to question: It’s not my bank yet, but just how much is this going to affect me? Should I keep all my cash under the mattress?

Experts in the University of Delaware’s Alfred Lerner College of Business and Economics have been following all this closely. Here’s what some of them with a focus in banking, accounting and economics have to say on what people should know about these bank failures.

There’s no need to panic and switch banks

It’s true that smaller community banks may not get the same solicitous bailout considerations from the federal government as the banking giants. But the experts are unanimous: Your money is safe in the bank.

This is not because your bank can’t fail, but because the Federal Deposit Insurance Corporation guarantees deposits up to $250,000. Most of us don’t have to check very often to see if our account balance is over that number, so joining the big investors stampeding to JP Morgan Chase or US Bank isn’t logical.

It’s an overreaction, said Amanda Convery, an assistant professor of accounting. “Does that really make any sense to go through all that stress (of switching) if you’re not falling above those limits anyway?”

When events like this happen, she said, “take a breather, and think about where you are in the situation.”

So can most of us conclude that this crisis won’t affect us at all? Sadly, no.

Banks’ problems can become yours

Banks of any size are crucial to the economy, points out Michael Gelman, an assistant professor of finance who researches banking. They’re important for making the loans you need to pay for college or a new home. They also lend to businesses, which can then invest in projects that create jobs. At the same time, the banks safeguard the money needed to meet payroll.

While big banks grab the headlines, don’t underestimate how much small banks contribute. Gelman cites data published by the Fed: Small to medium sized banks offer 38 percent of the loans in the U.S., 37 percent of home loans and other residential real estate credit, and a whopping 67 percent of commercial real estate loans.

A note here: When it comes to size, SVB was no JP Morgan, but at 16th-largest in the country, it wasn’t exactly a mom-and-pop either.

“Smaller banks that operate in smaller towns and rural areas, and provide credit for small businesses are an important part of the economy,” Gelman said.

Despite that, they’re at a disadvantage. When interest rates go up, these smaller banks have a harder time competing for money with large ones, Gelman noted, and recent events have only made that more challenging.

The upshot is that if panic spreads throughout the banking system, this can mean real trouble for the economy. That’s why the FDIC acts quickly to combat broader negative effects on the banking system and the economy as a whole.

What are some of the impacts people could notice from this?

The banking crisis could have a few different effects in the coming months, some good, some bad.

“Up and down the loan applicant pool, banks are going to be scrutinizing everything a lot more carefully,” Stacie Beck, associate professor of economics, said. “So it will probably lead to people who used to be able to get loans having a harder time doing it, and having to face higher restrictions on it.”

Wealthy people or those with a high credit score will still be able to get loans, Gelman said, but for others it could get more difficult.

Another impact on the economy could come for businesses working on multi-year projects that relied on low interest rates, Beck said. If they get in a situation where they have to carry over some of that debt with a new loan, they’ll face higher interest rates and might have to declare bankruptcy.

Another pinch on credit, she noted, might come if the value of assets like homes goes down as interest rates rise. Those assets are used as collateral on other loans, so that could cause even more issues with getting credit.

At the same time, it’s not all bad news for the average consumer. If you’re someone with money in a savings or checking account, Convery pointed out, you could benefit from higher interest rates. Local banks now may give you a higher interest rate to earn your money and keep you with them, she said, and you can shop around for the best rate.

As an example, she pointed to Apple Card recently offering a 4.15% rate on a savings account.

But it’s complicated. Your gain may be a bank’s loss.

What caused all these bank failures?

Why are banks suddenly wobbling? Beck boils it down to rising interest rates, the same factor that can get you extra money in a savings account.

To keep you from taking your money elsewhere, the bank has to pay more interest. To do that, it may have to sell investments like government bonds, Beck noted. But lower-interest bonds tend to lose market value as interest rates rise and other investments become more appealing.

That can be a real problem.

Silicon Valley Bank had invested heavily in government bonds, a safe investment. They didn’t have enough available to pay depositors who wanted their money back, so they had to sell the bonds, Gelman said. However, the bonds had lost value and SVB didn’t have enough resources to absorb that loss.

It doesn’t sound like Silicon Valley Bank was particularly well managed, Beck said, but she thinks without the interest rate pressure it might have been able to survive.

“Banks are really not able to handle quick (interest rate) movements like that,” she said. “… Where was the San Francisco Fed? They should have known that there was pressure on these banks; they should have been finding out how things are going … somebody was clearly asleep at the switch. That’s not good.”

It’s rare for a bank rated as strongly as SVB to collapse so quickly, Beck said. If it’s not because of fraud, and turns out to be from the impact of interest rates, “then this problem is system-wide. And if it’s system-wide, then what will happen is a series of very stressed banks.”

This happened in the ‘80s, she noted, as bank after bank fell into crisis. “This is not an unknown problem.”

Another factor in failures is tied to banks’ actions. In a recent working paper, Gelman and a co-author report that an increase in deposits can lead to negative consequences, as banks may take more risks. In periods of monetary tightening, like when the Fed raises rates, those banks face greater losses, and people take their money out of smaller and more constrained institutions. They argue this can explain the recent fragility in the banking system.

Be aware — this is going to be in the news for a while

The economy is enormously complex, which is why it’s difficult for Warren Buffet, UD experts, or anyone else to predict exactly how it will react in the coming months. But one thing you should expect is ongoing news about what happened to the collapsed banks, Convery said.

The audit firm that gave SVB a clean bill of health, for example, is facing scrutiny.

“Over the next six months, we’ll probably hear stories around these investigations and Silicon Valley Bank, and it doesn’t mean that we’re back to March 2023,” she said.

She urged people to have patience and not overreact. It takes time to investigate the financial practices of companies like this, what exactly went wrong and who was to blame. Hearing constant news about it is not a reason for people to panic, run to their medium sized bank and withdraw all their money.

Rather, it’s a result of the process, which is about getting the investigation right rather than coming to a quick and sensational conclusion, Convery said.

“Systems are in place to check to make sure that OK, if there’s something that needs to be improved, we’ll do it.”

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