The banking System in crisis might have felt like a sudden apocalypse that dropped out of nowhere, but the reality is far from it. It’s a consequence of several factors that brewed for years – like a perfect storm. Firstly, the economy was flooded with $4 trillion in printed stimulus, leaving moneybags feeling richer than ever. Secondly, interest rates were held at 0% for years, which made borrowing a piece of cake. On top of that, the Fed was out there buying bonds and ETFs like they were going out of style. If all that weren’t enough, inflation has been soaring for a record-breaking 22 months straight! The truth is, we’ve been basking in the glow of “free” money for years, and it’s finally time to pay the piper.
The recent collapse of Silicon Valley Bank, Silvergate, and Signature Bank has caused a panic among the investors in the stock market. Trading in more than 30 banks in the US has been halted due to volatility, shaken confidence among investors, and fears of instability. The NYSE has halted trading in Charles Schwab, one of the largest banks in the world. This article discusses the risks faced by the banking system in the absence of an explicit government guarantee for depositor funds and the need for a temporary systemwide deposit guarantee to restore confidence in the banking system.
KPMG, the accounting firm that signed off on the audit of Silicon Valley Bank, failed to identify the potential risks associated with the bank, leading to its collapse. Signature Bank, which also had a clean bill of health from KPMG, failed 11 days later, further highlighting the inadequacies in the audit process. This has led to trading being halted in several banks due to volatility and fears of instability.
Banking System in Crisis and Risks Faced by the Banking System:
The recent events in the US banking system have caused concern among depositors who previously considered their money to be safe. This is due to the two-tiered system that has been in place since the Global Financial Crisis (GFC) in 2008. The system consists of a few large banks that have the explicit backing of the taxpayer, while the rest have $250k of deposit insurance.
However, this system has been proven to be unreliable, as recent events have shown. In a world where information can spread rapidly, no bank is safe from a run unless the depositor has an explicit government guarantee that ensures complete access to the total value of their deposits. This means that if a bank fails, the depositor must have access to their money, or there could be a run on the bank.
The lack of an explicit government guarantee for all depositors has increased the risk for depositors, as they are left vulnerable to bank failures. This is particularly true for non-systemically important banks (non-SIB banks), which are not backed by the government and are therefore more likely to experience large withdrawals.
The need for an explicit government guarantee for all depositors is crucial to maintain the stability of the US banking system. This would ensure that all depositors have complete access to the total value of their deposits, regardless of the size or importance of the bank. Without this guarantee, the public will continue to view the banking system as unreliable and risky.
The problem is compounded by the stock market, where consumers understand that when a bank stock collapses, it is only a matter of days before the bank fails due to liquidity demands by their depositors. The rewards for being a depositor are minimal compared to the risk of losing access to funds needed to run businesses or households. Until this problem is solved, the banking system is at risk. The more time the public is exposed to a period of uncertainty, the more imprinted deposit risk is on the mind of the public.
Banking System in Crisis and Temporary Systemwide Deposit Guarantee:
It is critical that the government promptly puts its full faith and credit behind the deposit system to restore confidence in the banking system. If a deposit is safe if a bank fails, as in SVB and Signature, then why is it difficult for the government to confirm that a deposit is money good when the bank is still operating? We need a temporary systemwide deposit guarantee that will remain in place until our outmoded $250k deposit guarantee program is modernized.
The lack of confidence in the banking system has necessitated the need for government intervention to restore confidence. The government needs to put its full faith and credit behind the deposit system by providing a temporary system-wide deposit guarantee that will remain in place until the current deposit guarantee program is modernized. This will provide assurance to depositors that their deposits are safe and can be accessed even if their bank is facing financial difficulties.
Since this new system cannot be created over a weekend, we need a stop-gap measure to get us through the next few days and weeks. The alternative is one bank failure after the next. The weakest three have already fallen, and the market is already telling us who is number four. This is not the way to maintain confidence in a banking system.
Banking System in Crisis and its Impact on Small and Medium-Sized Businesses:
The recent bank failures and the volatile trading in bank stocks have raised concerns about the impact on non-systemically important banks, particularly small and medium-sized businesses. As more banks fail, the cost of capital for non-SIB banks is likely to increase. The reason for this is that when banks fail, depositors withdraw their funds, and this puts pressure on the remaining banks to maintain liquidity. To do so, banks may need to increase their capital reserves or seek additional funding through more expensive sources, such as borrowing from the Federal Reserve.
This increase in the cost of capital can have a significant impact on small and medium-sized businesses, as they often rely on bank financing to fund their operations and growth. The higher cost of capital can make it more difficult for these businesses to access the capital they need to operate and expand, and this can have long-term effects on the growth and development of the economy.
It is important to note that the rise in the cost of capital for non-SIB banks is not solely due to bank failures. There has been an overall rise in interest rates, which has contributed to an increase in the cost of borrowing for businesses. However, the recent bank failures and the resulting increase in the cost of capital are likely to exacerbate this trend.
In light of these concerns, it is important for policymakers to take steps to support the banking system and prevent further bank failures. One approach could be to provide temporary deposit guarantees to restore confidence in the banking system and prevent depositors from withdrawing their funds. This would help to stabilize the banking system and reduce the pressure on non-SIB banks to maintain liquidity.
Another approach could be to provide additional support to small and medium-sized businesses, such as targeted loans or tax incentives. This would help these businesses to access the capital they need to grow and expand, despite the higher cost of capital.
FDIC Assets Cover Only 1.26% of Deposits:
The FDIC’s current financial standing raises concerns about the ability of the agency to handle a potential wave of bank failures. As of now, the FDIC has only $124.5 billion on its balance sheet and a $100 billion line of credit, which is significantly lower than the US banking system’s total value of over $22 trillion. Furthermore, the FDIC’s assets cover only 1.26% of total deposits in the banking system.
This disparity highlights the need for a temporary systemwide deposit guarantee that can restore confidence in the banking system and prevent bank failures. The current two-tiered system, where only a few large banks have the explicit backing of the taxpayer and the rest have $250k of deposit insurance, is inadequate and has failed in the past.
In a world where information spreads rapidly and withdrawals can be made with the push of a button, any bank can become vulnerable to a run unless the depositor has an explicit government guarantee that ensures they have complete access to the total value of their deposits. Without such a guarantee, non-systemically important banks (non-SIB banks) are likely to experience large withdrawals, and the market’s loss of confidence in a bank’s ability to operate can lead to stock collapses and bank failures.
A temporary systemwide deposit guarantee, which remains in place until the $250k deposit insurance program is modernized, is necessary to avoid bank failures and restore consumer confidence in the banking system. In the absence of such a guarantee, weak banks will continue to fail, which will increase the cost of capital for non-SIB banks, thereby impacting the cost of capital for small and medium-sized businesses. This, in turn, will have a profound long-term impact on the economy, making it imperative to address the issue of deposit guarantees promptly.
In conclusion, the recent events in the US banking sector have highlighted the risks associated with investing in bank stocks and being a depositor. A two-tiered system that has been in place since the GFC has worked until it hasn’t. A temporary systemwide deposit guarantee is needed to get us through the next few days and weeks, and until the $250k deposit guarantee program is modernized. The FDIC’s limited assets cover only a small fraction of the deposits in the US banking system, and the cost of capital for non-systemically important banks will increase if more banks fail. This will have a long-term impact on the cost of capital for small and medium-sized businesses, which are critical drivers of the economy.