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The Banking Crisis of 2023 – What We Know, What Comes Next, What We Should Do

March has been a wild and wooly month so far, with high volatility continuing to roil the global stock markets and central banks continuing to put pressure on bond markets. But the most interesting story of the last couple of weeks — and the one that’s sparked the most conversation with clients — is sudden turmoil in the banking industry.

 

What Happened?

On March 8th, a small bank that mostly served cryptocurrency companies, Silvergate Capital, announced that it was shutting down. The ongoing trouble in the crypto world, headlined by the collapse of FTX, had prompted large withdrawals from Silvergate — which had forced it to sell some of the bonds it held as part of its reserves, at a significant loss. On the 9th, announcements from Silicon Valley Bank that it had likewise had to sell bonds at a loss, and had tried to raise cash by selling some of its own shares, spooked venture capital supporters and clients; depositors demanded more money than the bank could raise, and it was forced to close. On the 10th, Signature Bank, another bank serving crypto-related clients, also faced depositor demands it couldn’t meet, and closed. Over the course of the next week, other banks faced similar pressures and came near collapse: First Republic Bank, for example, avoided disaster when it secured a $30 billion “rescue package” from a group of big banks.

There are some common threads to these stories, nicely summarized in an article at the Wall Street Journal (WSJ): These were banks that had made large commitments to relatively narrow niches in the economy, putting themselves at more risk than they may have recognized. They were caught flat-footed by the rapid rise of interest rates over the course of 2022, and didn’t make significant adjustments to the bond portfolios that held their reserves. When crypto companies needed to make large cash withdrawals from Silvergate and Signature, and other tech firms made similarly large demands at Silicon Valley, there just wasn’t enough cash available in the banks.

Strictly speaking, none of the troubled banks have received a “bailout”: some have failed, and some have found private-sector support, but none have been directly propped up by the government. On the other hand, Federal bank regulators agreed to “guarantee all deposits”, even above the FDIC insurance limit of $250,000, for those who had deposits at Signature Bank and Silicon Valley Bank. Similar protections could be extended to clients of other banks, if the crisis continues. And the Federal Reserve has announced a new program (Federal Reserve) that will allow banks to borrow against the bonds in their reserves at face value, rather than sell them at a substantial loss.

 

What’s Next for Banks?

These two measures appear to have provided at least some support for the small and mid-sized banks that were most at risk of the same sort of trouble … for the moment, at least, preventing significant “contagion”. And two important things appear in research from MSCI. First, all banks have been hurt by the crisis, and their stocks and bonds have sold off significantly during this crisis. But second, “regional” banks, which tend to be small to mid-sized, have been hit harder than the biggest banks.

The failures of these few banks, and the stresses on so many others, seem to Liz Ann Sonders (Chief Investment Strategist at Schwab) to be just the sort of “something breaking” that will allow the Federal Reserve to change its current strategy of continued interest rate hikes. And Larry Fink, CEO of financial mega-firm BlackRock, has argued that the rate hikes the Fed has already completed have “exposed cracks in the financial system” — but that the regulators’ “swift and decisive actions” have probably been enough to limit the damage.

Interestingly, Sonders has said that she believes that the main sort of “panic” that we are feeling about the current bank crisis is not a systemic problem, but “psychological”. With our worries fed by the virality of the story on social media, amplified by other popular media (including stories on NPR), it seems like we’re all wondering if we need to take dramatic action. A CNN headline asks, “Should I pull my money out of the bank?” (CNN), and some of our clients have called in to ask us the same question.

 

What Does It Mean, and What Do We Do Now?

Last week, we looked closely at the investments our clients own, and we found that many of our ESG mutual funds and model portfolios (those which make Environmental, Social, and Governance issues a core part of their investment process) held shares of Silicon Valley Bank. In part this was because they supported some really interesting start-up companies in industries like alternative energy, clean-tech, and bio-tech — and because they had pretty good diversity policies. Its failure, though, was not due to its ESG policies, but rather to errors in its reserve investments.

What’s more, the amounts owned by our clients tended to be small, so they won’t have been significantly affected by the bank’s failure. Our policies of broad diversification protect us against this sort of idiosyncratic issue. For example, if we have 5% of a client’s portfolio in a particular fund, and it had a 1% allocation to one of these now-failed banks, the resulting loss would be drowned out by the noise emitted by other parts of the client’s portfolio.

If these bank failures are “contained”, no matter how outrageous and spectacular they have been, then in the long run we’ll probably find that they are nothing more than a short-term shove on the markets and the economy. It’s possible, though, that the Federal Reserve could look at the failure of these banks, and see it as a signal that interest rate hikes have had a significant enough effect on the US economy, and they can change interest rate policy direction. Such a change could, in turn, give the stock and bond markets a moment to catch up to all that’s happened, and adjust expectations for the near future.

For most of our clients, our recommendation stays the same: Let’s stick to our long-term plans, and ride out the day-to-day fluctuations of the markets. A few of our clients have substantial cash on deposit with various banks and credit unions: if you’re concerned, we can revisit those deposits, and see if there are ways to move those deposits around so that they’re protected by FDIC insurance and can earn reasonable rates of interest. And of course, all of our clients can rest assured that we’re keeping a close eye on this crisis.

During the “Global Financial Crisis” of 2008-09, many of us were concerned that the “too big to fail” banks were being supported at all of our expense. Those bailouts may have turned a profit, or maybe cost us billions, but they appear to have played an important role in sustaining the global financial system. So far, the Bank Bust of 2023 appears to be relatively minor by comparison, with no real bailouts and no significant impact on the overall economy. Although market movements don’t lend themselves to any sort of guarantees, we don’t see any reason to think that the current situation will develop into anything bigger.