According to a recent study published by the Social Science Research Network, almost 200 US banks could face the same fate as Silicon Valley Bank (SVB) if certain market conditions are met.
The study formulated a hypothetical scenario in which each of the 186 banks experienced a run, which concluded that the Federal Deposit Insurance Corporation (FDIC) would run out of money.
The study’s authors highlight that these banks’ assets are primarily invested in government bonds and mortgage-backed securities that have been negatively impacted by the Federal Reserve’s interest rate hikes.
SVB’s collapse, the worst American financial institution failure since 2008, was triggered by the bank’s heavy investment in long-term government bonds and mortgage-backed securities.
While these securities are typically sound long-term investments, they were not worth as much as when SVB initially purchased them. SVB sold these bonds at a significant loss to meet customer withdrawals, leading to a run on the bank as depositors panicked and withdrew their money.
The study notes that uninsured depositors withdrawing even a small percentage of their funds could cause substantially more banks to be at risk. The study’s abstract states that almost 190 banks are at a potential risk of impairment to insured depositors, with up to $300 billion of insured deposits at risk if half of uninsured depositors decide to withdraw their funds.
Fragility of the US banking system
The study suggests that recent declines in bank asset values significantly increased the fragility of the US banking system to uninsured depositor runs.
However, the authors note that other government interventions or recapitalization could prevent such failures. In the current banking crisis, the Biden administration has taken measures to calm customers and prevent contagion in the banking system, including backstops that do not require direct government spending from taxpayers, such as the Federal Reserve’s actions.
The vulnerability of US banks to potential runs is a reminder of the importance of risk management and regulation. Smaller banks must ensure that they have adequate liquidity and diversify their assets to mitigate potential risks. The Federal Reserve’s recent interest rate hikes have also highlighted the need for banks to be mindful of the potential impact on their investments.
While it is unclear which banks are at the greatest risk, the study serves as a warning to the banking industry and regulators to be vigilant and take necessary precautions to prevent future failures.
The authors conclude that these calculations indicate that recent declines in bank asset values have significantly increased the fragility of the US banking system to uninsured depositor runs.