The banks are, to a large extent, casualties of the US Federal Reserve’s aggressive monetary tightening policy. Although the federal funds rate, at 4.5% to 4.75% currently, is still low by historical standards, the rise (from near zero) has been very steep — happening over a period of less than a year. As a result, traditionally low-risk bonds, including the “safest” US Treasuries, suffered their worst losses on record in 2022. Bonds have fixed income streams, whose values fall when interest rates rise. The longer the term to maturity, the worse the drop. Recall our equation for valuations for stocks and bonds from last week, whereby the intrinsic value (V) is the sum of discounted future cash flows (DCF).
The high-profile failure of Silicon Valley Bank (SVB) and fears of contagion sent US and global markets into a tailspin last week. Bank stocks were particularly hard hit. To very briefly recap, SVB was taken over by US banking regulators on March 10 after suffering a bank run that resulted in “inadequate liquidity and insolvency”. (All banks operate on fractional reserve banking, where only a percentage of deposits are kept in cash for immediate withdrawal. Thus, a sudden rush of customers to withdraw their money all at once will trigger a liquidity crisis. Traditional bank runs are made worse in the age of social media and instantaneous information, where panic can spread like wildfire.)
Then, over the weekend, a New York financial institution, Signature Bank, was closed by regulators after it, too, reported a bank run on the same Friday as contagion fears spread to other smaller, regional banks perceived to be more vulnerable, due in part to their narrower customer bases. That makes it the third bank to be shuttered in a week, including Silvergate Capital, which voluntarily shut down earlier. SVB (a 40-year-old bank) and Signature (founded in 2001) are the second- and third-largest banks to fail in US history, the biggest being Washington Mutual Bank in 2008. Both banks are now under receiverships with the Federal Deposit Insurance Corp.
