In 2023, the US banking sector faced a serious crisis that massively impacted global finance. The chain of events wasn’t a one-time issue but part of ongoing economic challenges from 2022. The crisis mainly involved multiple bank failures, starting with Silicon Valley Bank (SVB), the country’s 16th largest, which collapsed quickly on March 10, 2023. This triggered a cascade effect, causing Signature Bank (SBNY) and First Republic Bank (FRB) to follow suit. These were the biggest bank collapses since 2008, notably Washington Mutual Bank on September 25.
The upheaval began when a large number of customers withdrew their funds from the SVB. The total withdrawal figure of $142 billion in about a couple of days represents a staggering 81% of SVB’s $175 billion in deposits as of year-end 2022. Particularly worrisome were other banks of similar or smaller size holding substantial uninsured deposits, unrealized losses, and exposure to commercial real estate.
What Else Increased Bankers’ Anxiety after SVB’s Failure
The convergence of tighter monetary and financial conditions, coupled with these accumulating vulnerabilities, underscored the fragility inherent in the banking system.
When inflation started to rise, central banks, notably the Federal Reserve, responded by increasing interest rates from early 2022 to early 2023. This move aimed to control inflation but had unintended consequences for banks. They saw a decrease in the value of their assets, notably in the U.S., where bank assets dropped by around 10%, totaling a significant decline of $2.2 trillion, matching their overall capital.
The rising interest rates impacted the stability of banks, particularly in the U.S. A study found that if a portion of uninsured depositors withdrew their funds, nearly 190 banks with a combined $300 billion in assets could have faced insolvency. This scenario became reality with the collapse of SVB, which had a high reliance on uninsured funds and leverage, leaving it vulnerable.
The banking system’s vulnerabilities were not solely tied to interest rate exposure. Losses on securities held by banks also left them susceptible to sudden funding shortages when interest rates spiked in early 2022. And the fragility of the banking system became more apparent when several banks failed in March.
Moody’s Downgrades Banks in Commercial Real Estate
In the aftermath, economists were cautioning about the potential for another banking crisis. Their concerns were well-founded, given several contributing factors. Firstly, the downgrades of banks heavily invested in commercial real estate (CRE), particularly office space, had raised red flags about the sector’s stability. In August, Moody’s, a credit rating agency, downgraded the ratings of ten small- to mid-sized banks, with M&T Bank Corporation being hit the hardest. These included familiar names like Commerce Bancshares and BOK Financial Corporation.
In addition, six other banks were put on notice for possible downgrades, including Bank of New York Mellon Corporation and U.S. Bancorp. Moody’s also changed the outlook for eleven banks from stable to negative, indicating potential troubles ahead. This included big players like PNC Financial Services Group and smaller ones like Simmons First National Corporation. These changes clearly signaled then a broader sense of concern within the banking industry.
Adoption of Remote Work During the Pandemic
The widespread adoption of remote work during the Covid-19 pandemic significantly reduced the demand for office spaces, leaving banks with substantial CRE portfolios exposed to risk. Let’s dig into how this trend is putting banks at risk and why economists are sounding the alarm:
First off, there was a significant drop in demand for office spaces due to the pandemic pushing more people to work remotely. This surplus of empty offices was causing headaches for banks, especially since they were heavily invested in Commercial Real Estate (CRE) lending. With fewer people needing office spaces, landlords were struggling to make ends meet, which meant they were finding it tough to pay back their loans to the banks.
We were already seeing signs of trouble then, like more missed payments on commercial mortgage-backed securities. Even smaller banks were trying to distance themselves from CRE lending, worried about the potential for defaults as office vacancies rose and property values fell.
Economists were worried this could have all led to a higher rate of defaults among CRE owners. Moreover, the timing wasn’t great — many of those loans were coming due soon, and if landlords couldn’t cover the payments or find other ways to finance them, we could have seen even more defaults piling up.
How Banks Suffered Increased Interest Rates
Also, the increase in interest rates from Q1 2022 to Q1 2023 had a big impact on the value of assets held by U.S. banks. This led to significant losses on the ‘books’ of these banks, affecting their stability.
From March 7, 2022, to March 6, 2023, the Federal Reserve raised interest rates by about 4.5 percentage points. This move aimed to control inflation but had a big effect on banks.
The rate hike caused U.S. banks’ assets to lose value. On average, their assets dropped by 10%, totaling a huge $2.2 trillion loss, almost matching their total capital. This loss hurt banks because their assets were worth less than what they owed.
Smaller banks, with less diverse investments and more tied to local economies, faced still tougher times. Higher rates meant they paid more for funding and saw the value of their fixed-rate loans drop. This made it hard for them to compete with bigger banks.
As rates rose, both people and businesses struggled financially. U.S. credit card debt soared to over $1 trillion, with the average interest rate hitting 16.13% by November 2021. Higher rates often mean more missed payments, leading to more defaults and putting pressure on banks. And the same thing happened; dozens of them eventually collapsed.
Systemic Risks Within the Banking Industry
The tightening of lending rules and the potential imposition of further limitations on at-risk banks by regulators indicate ongoing systemic risks within the banking industry. The Federal Deposit Insurance Corporation (FDIC) has identified various significant risks such as credit, market, operational, crypto-assets, and climate-related financial risks confronting banks. Failure to manage these risks adequately could result in a recurrence of past banking crises.
Tightening of Lending Rules: Regulators are making lending standards tougher to lower risks across the whole banking system. For example, Andrea Enria from the ECB said banks need to be careful with who they lend to, to stop risks from spreading. Some studies say these rules are causing problems for banks, while others say they’re not making much of a difference.
FDIC’s Identified Risks: The FDIC’s review in 2023 listed several risks banks are facing, like credit, market, operational, crypto-asset, and climate-related risks. These are made worse by how the economy and financial markets are doing, and by what’s been happening in the banking world since March 2023.
Credit Risk: One big worry is that people might not be able to pay back their loans, especially in areas like farming, commercial property, and personal loans.
Market Risk: Banks are also keeping an eye on market risks, such as changes in how much cash is available and shifts in interest rates. They need to manage these well to keep making money and not lose what they have.
Operational Risk: The FDIC says banks need to be really careful with things like technology and protecting against cyber attacks. Messing up here could be a big problem.
Crypto-Asset Risk: The rise of digital currencies like Bitcoin brings new risks for banks, which the FDIC has noticed and talked about in its review.
It could be disastrous if banks don’t handle these risks well. For instance, between 2008 and 2012, the biggest banks in the world lost about $200 billion because they didn’t deal with risks properly. Also, if interest rates go up, banks need to be really careful to protect their money and profits.
Renewed Pressure of 2023 Banking Crisis in Financial Markets
The 2023 banking crisis has eased off after six months, but there’s renewed pressure in financial markets. Economists are worried about signs that another crisis might be brewing. This is due to a complex blend of economic, market, and banking industry factors. The Conference Board’s report on the 2023 Banking Crisis offers a thorough breakdown of these factors and provides practical guidance for executives to manage through this period of uncertainty.
Economic Factors: The economy is slowly recovering from the pandemic, but inflation remains high. To tackle this, central banks like the Federal Reserve are raising interest rates, which could lead to a brief recession by the end of 2023.
Market Factors: Financial markets are stressed out, especially for banks heavily invested in CRE. This stress is worsened by the expectation of more financial tightening due to the banking crisis.
Banking Industry Factors: Banks are still relying on loans from the Federal Reserve to stay afloat, and confidence in the banking system seems shaky.
Advice for Executives: The Conference Board suggests that financial firms should keep extra cash handy, watch out for risky assets, and avoid launching new products. For other companies, it’s about extending funding sources, keeping plenty of cash on hand, and planning for the worst.