In early 2023, the financial landscape witnessed a series of events as several banks faced unexpected collapses and had to sell off their operations. These incidents not only highlighted vulnerabilities within the banking sector but also shed light on the complex interplay of factors that led to these downturns. From crypto lenders to traditional financial institutions, no one was immune to the challenges that unfolded. While the number of bank failures experienced so far in 2023 falls short of the several dozen that failed each year between 2008 and 2013, 2023 has proved to be the most costly.
1. Silvergate Capital: Cryptocurrency Woes Lead to Liquidation
The turmoil began with the collapse of Silvergate Capital, a US bank deeply connected to the world of cryptocurrencies. With strong ties to crypto exchange FTX and crypto hedge fund Alameda Research, Silvergate was at the forefront of the crypto movement. However, the cryptocurrency crisis took a toll on FTX and Alameda Research, ultimately cascading into Silvergate’s troubles.
When regulatory scrutiny hit Silvergate for potential fraud, depositors began withdrawing their funds, causing a domino effect. The bank was compelled to sell assets at a loss to accommodate customer withdrawals. Silvergate decided to wind down operations and liquidate on March 8th as losses mounted.
2. Silicon Valley Bank (SVB): An Interest Rate Risk Nightmare
Silicon Valley Bank’s downfall underscored the dangers of interest rate risk. As a haven for tech and biopharma startups, SVB used their deposits to invest in fixed income securities, including US Treasuries and mortgage-backed securities. The economic slowdown in the tech and biopharma sectors forced startups to pull their deposits, leading SVB to sell its investments to fund withdrawals. Unfortunately, rising interest rates diminished the value of these investments, causing a staggering $1.8 billion in capital losses.
Unable to secure fresh capital to cover these losses, SVB hemorrhaged $40 billion in deposits, prompting the FDIC to intervene and assume control on March 10th. Regional bank First Citizens later acquired SVB’s deposits, loans, and branches.
3. Signature Bank and Flagstar Bank: Ripple Effects of Crypto Turmoil
Signature Bank, another institution with links to the crypto industry, witnessed a similar pattern. Withdrawing customers eroded about 20% of the bank’s deposits, prompting US regulators to step in on March 12th. Flagstar Bank, a New York Community Bancorp subsidiary, subsequently acquired Signature Bank’s deposits and selected loans.
4. Credit Suisse: A Collapsing Giant
Credit Suisse’s collapse differed from its US counterparts, as its demise was not solely driven by cryptocurrency or interest rate risks. A series of losses, scandals, and strategic shifts culminated in the bank’s downfall:
- A $5.5 billion loss linked to loans to Archegos Capital Management in 2021
- Over $4 billion paid in settlements and fines between 2020 and 2022
- Nearly $3 billion in restructuring costs as the bank aimed to shift from investment banking to wealth management
- Wealthy clients’ loss of confidence led to significant fund withdrawals
Credit Suisse’s troubles worsened when the SEC forced the delay of its annual report due to financial reporting “material weaknesses.” This triggered a market decline and impending collapse, averted only by UBS’s agreement to acquire the bank.
5. First Republic Bank: Second Largest US Bank Collapse
On May 1st, First Republic Bank faced a disastrous outcome, ranking as the second largest bank failure in US history after the 2008 collapse of Washington Mutual. Like SVB, First Republic’s downfall was rooted in poor interest rate management and liquidity risks.
At the beginning of 2023, the bank reported that between January 2022 and January 2023, interest expenses surged over 2000%. Then, in April, it reported a 41% outflow in deposits for the first quarter of 2023. As a result of the run on deposits, the FDIC announced the ‘bank’s closure and most of its assets were sold to JPMorgan Chase.
Lessons for Tomorrow
The banking sector faces several challenges in the near future:
- Significant unrealized losses on long-term investments
- Challenges in growing deposits
- Impending defaults in commercial real estate
Significant unrealized losses on long-term investments
Banks, including regional ones, incurred massive unrealized losses on long-term Treasury and mortgage-backed bond investments due to rising interest rates. As of 2022, US banks had accumulated $620 billion in unrealized losses on these securities, risking liquidity issues and the need to sell assets at substantial losses if they experience a run on deposits.
Challenges in growing deposits
Banks face challenges growing and retaining deposits as customers look for higher interest rates. This demand for deposits increases interest expense as banks are forced to offer higher rates to compete with other institutions. With fewer deposits and rising interest expense, banks will be forced to issue fewer loans and at higher rates, which can hamper economic growth. In addition, lower deposits also puts banks at risk for liquidity issues, as discussed above. To help combat the impact of lower deposit levels, a slowing economy, and tougher liquidity rules, banks have increased the amount of cash they hold to $3.3 trillion an increase of 5.4% from December 2023 to August 2024.
Impending defaults in commercial real estate
Smaller banks, especially regional ones, are exposed to a downturn in the commercial real estate market due to remote work trends. Office vacancy rates have risen significantly, impacting the value of commercial real estate owned by banks. Default rates are increasing, and many commercial mortgages held by banks are set to mature soon, potentially causing defaults if borrowers can’t refinance.
Commercial lending by US banks has decreased, and a lending slowdown poses risks to the broader economy that relies on financing for growth and job creation. The Federal Reserve is monitoring credit availability while deciding on further interest rate hikes.
The tumultuous events of early 2023 are a stark reminder that even established financial institutions are not immune to changing economic and industry conditions. These incidents highlight the importance of prudent risk management, adaptability to changing economic environments, and transparency in financial reporting.
Banking regulations have come under scrutiny after the SVB collapse, with calls to examine existing rules and make them more stringent. Banks have sometimes reclassified losses to obscure risks, and certain accounting tactics have drawn regulatory attention.
As resilient as it is, the banking sector must continuously evolve to navigate a rapidly evolving financial landscape. While a full-scale crisis like 2008 is not predicted, ongoing vigilance and regulatory adjustments are necessary to safeguard the banking sector’s stability.