Banking Crisis 2023 Explained: What Investors Need to Know

What is the banking crisis?

This year's bank collapses have been some of the biggest in US history, and there are many factors behind them.

Higher interest rates and poor management decisions are part of what has caused these failures, which are reminiscent of the down days seen in 2008. Sentiment has also played a role — fear is a powerful agent in the marketplace, and it can wrap around investors very quickly, leading to sudden swings in momentum.

It's perhaps unsurprising then that institutions such as the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve Board quickly stepped in to prevent further damage after the banking issues began.

“Policymakers also noted that actions taken by the Fed and other government agencies to mitigate possible contagion and secure the US financial system had successfully quelled immediate fears and calmed conditions in the banking sector,” CNN states.

Which banks have collapsed in 2023?

The bank that kickstarted the sector's problems was the aptly named Silicon Valley Bank (SVB), which primarily serviced the tech industry — its spectacular collapse will be talked about for years to come.

Although it was one of the 20 biggest commercial banks in the US, SVB was relatively unknown before its failure suddenly catapulted it into the spotlight. At the crux of its problems was that the bank invested short-term deposits in long-maturity debt. After selling securities at a loss and then attempting to raise US$2.25 billion, investors got worried.

“SVB’s condition deteriorated so quickly that it couldn’t last just five more hours,” Better Markets CEO Dennis M. Kelleher said soon after SVB took a turn for the worse. “That’s because its depositors were withdrawing their money so fast that the bank was insolvent, and an intraday closure was unavoidable due to a classic bank run.”

The assets of the bank were seized by the FDIC in early March.

After the spectacular collapse of SVB, the next bank run did not take long to arrive; in fact, it happened only a couple of days later, when New York-based Signature Bank collapsed in the third largest bank crash in US history. According to the FDIC, Signature Bank’s woes can be traced back to the pursuit of “rapid, unrestrained growth” by a “poor management” team.

Signature Bank shut down in mid-March, two days after the SVB closure. The bank saw deposit outflows of US$42 billion in one day. Some of its assets were eventually acquired by Flagstar Bank, a subsidiary of New York Community Bancorp (NYSE:NYCB).

Then came First Republic Bank. The San Francisco-based bank began crumbling after it reported a drop of over US$100 billion in deposits for the first quarter. The news sent its shares on a dramatic fall.

Fears from First Republic customers began bubbling quickly, with clients looking to bigger banks for peace of mind. The crash was swift, and before anyone could say "bank run," the assets of First Republic Bank were headed for sale.

"With the closure of several banks in March, we experienced unprecedented deposit outflows," Neal Holland, First Republic's former finance chief, said before the collapse.

Following SVB's demise, US President Joe Biden said Americans should feel confident in the overall health of the country's banking system. "Your deposits will be there when you need them,” he commented.

“Small businesses across the country that deposit accounts at these banks can breathe easier knowing they'll be able to pay their workers and pay their bills, and their hard-working employees can breathe easier as well."

As mentioned, the US government has taken various steps to mitigate customers' concerns.

How is the banking crisis affecting the US economy?

The first US Federal Reserve meeting after the banking crisis began created a gloomy economic outlook. The central bank said it's likely the issues will push the US into a “mild recession” in the second half of the year.

The Fed has also played a critical role in the response to the banking crisis.

Michael S. Barr, the Federal Reserve Board's vice chair for supervision, authored a review of the SVB collapse as a way to find out where the Fed's response to the crisis could have been better. "Following Silicon Valley Bank's failure, we must strengthen the Federal Reserve's supervision and regulation based on what we have learned," he said in the report.

However, the Fed doesn't believe the collapses are indicative of the overreaching health of the market — instead, it sees them as outliers of a “sound and resilient (system), with strong capital and liquidity.”

The review recommends that the Fed’s supervision and regulation be increased, but ultimately points fingers at SVB’s board of directors and its management's inability to manage risks.

“While the proximate cause of SVB’s failure was a liquidity run, the underlying issue was concern about its solvency,” Barr said.

One of the biggest winners from the recent banking crisis, in one way at least, is JPMorgan Chase (NYSE:JPM), which ended up acquiring First Republic in a US$10.6 billion deal that was managed by regulators.

Jamie Dimon, CEO of JPMorgan, has dismissed concerns about the health of the banking market. “Our government invited us and others to step up, and we did. This acquisition modestly benefits our company overall, it is accretive to shareholders, it helps further advance our wealth strategy, and it is complementary to our existing franchise,” he said.

Are other banks in danger of failing?

While SVB, Signature Bank and First Republic were lesser-known names in the banking segment, their collapse one after the other has left many investors worrying about the health of larger banks.

Are these concerns valid? A study found there are nearly 200 banks at risk of collapse right now. The study, which was published at the end of March, was prepared by researchers from the University of Southern California, Northwestern University's Kellogg School of Management, the Columbia Business School Finance and Stanford University.

"We show that a bank’s survival depends on the market beliefs about the share of uninsured depositors who will withdraw money following a decline in the market value of bank assets," the report's abstract explains.

The authors trace this risk back to the status of uninsured depositors, meaning bank clients with no insurance on their accounts — these clients are more likely to try to withdraw their funds in the event of turmoil.

For the bank failures seen so far this year, a common trait is unrealized losses among institutions attempting to capitalize on long-term Treasury bond investments.

“When interest rates were near historical lows, the banks bought up on long-dated, seemingly low-risk Treasuries. But as rates rose, the value of those assets has fallen, leaving them sitting on unrealized losses,” CNN indicates. “High rates significantly constrained tech companies, which undercut the value of tech stocks and made it difficult to raise funds."

As questions about the health of the entire banking segment continue, one thing is clear: the crises experienced in 2023 have created new considerations in the sector — at least in the eyes of regulators.

“The combination of social media, a highly networked and concentrated depositor base, and technology may have fundamentally changed the speed of bank runs,” Barr notes in his report on the impact of the SVB crash.

In fact, Greg Becker, former CEO of SVB, believes social media is one of the reasons sentiment soured on the bank.

The executive has pointed to the actions of the Fed as one of the factors affecting banks like SVB. “The messaging from the Federal Reserve was that interest rates would remain low and that the inflation that was starting to bubble up would only be ‘transitory,’” he said as part of his testimony in a hearing in front of the US Senate Banking Committee.

What should investors do when banks collapse?

On top of sentiment concerns and worries about whether or not customers would be able to access their funds, the banking crisis also unsurprisingly caused a downturn in bank stocks.

Investors were quick to turn away from these names, showcasing their lack of confidence in the overall space.

Even for those interested in approaching struggling names in hopes of seeing bank stocks improve, Nancy Tengler, chief investment officer at Laffer Tengler Investments, told Bloomberg there’s no need to rush with this strategy.

“It’s not smart to chase some of these other bank stocks,” she said. “You have to let the falling knife fall.”

Beyond that, do mounting concerns about the bank system mean investors should begin thinking radically when it comes to planning their finances? As per usual, it depends on the type of investor. While there are some out there who are ready to escape the current financial system, most investors will not go to such extremes.

In an advice column, Gregory Germain, professor of law at Syracuse University’s College, writes:

So what should you do in this uncertain banking environment? First, you should have no concerns about the safety of your deposits in any insured bank or credit union as long as your deposits are under the $250,000 per person FDIC or NCUA insurance limits. If your bank gets into trouble, the FDIC or NCUA will quickly pay you back for your insured deposits. As long as your deposits are insured, your money is safe.

However, retail banks and credit unions are paying very low rates of interest on your deposits. A smart customer can earn much higher rates of interest through equally safe insured internet banks, treasury bills, and government money market funds. Consumers should shop around for maximum safe rates, keeping minimum amounts in their local banks to cover current expenditures. Money can easily be transferred electronically from other accounts to your local bank within a couple of days as necessary. As consumers move their money to earn higher rates, banks will be forced to compete by raising the interest rates they offer to attract deposits.

Germain further notes that in general it's not a good plan to keep over US$250,000 in the bank. While he acknowledges that this may be necessary for some businesses, he suggests spreading money among banks and other investments as a way to manage risk and incur higher rates of return.