In 2023, U.S. banks will collapse approximately every 90 days. Regional and smaller U.S. banking institutions have been buffeted by entrenched vulnerabilities, regulatory failures, market instability, failures in risk management, and other factors. The resulting chaos in regional and global financial markets. This article takes an in-depth look at the causes of the 2023 banking crisis, its implications, and possible solutions.
The following is the directory of this article:
What is the banking crisis of 2023? Timeline of the U.S. banking crisis
Causes of the Banking Crisis of 2023
Impact of a banking crisis in 2023
The role of technology and social media in the banking crisis of 2023
Responding to the Banking Crisis of 2023: The Solution?
Lessons Learned from the US Banking Crisis of 2023
Economic recovery after the US banking crisis
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1. Banking crisis in 2023
The 2023 banking crisis refers to the sudden collapse of U.S. regional banks, with severe repercussions for the global banking industry, although this collapse was to some extent predictable. A series of bank failures has had a domino effect, and this crisis is markedly different from the 2008 financial crisis, which mainly affected the giants of Wall Street. The crisis has rendered the "too big to fail" argument moot, as large banks such as Lehman Brothers and Bear Stearns could not weather the storm.
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2. Timeline of the Banking Crisis in the United States
While the U.S. banking crisis is largely focused on 2023, the broader timeline stretches back to 2019. Let's take a deeper look:
1. 2019 and the early warning signs
The Fed changed its stress-test norms, or custom rules, for banks, lowering liquidity standards for institutions holding less than $100 billion in assets. We will see how this further drives contagion in banking in 2023.
2. October 2022 sets off a chain reaction
Interest rates have soared around the world, making it harder for banks and even investors to borrow. This was the first spark that ignited the fuse of the "crisis".
3. January 2023
Banks like FRB and Signature Bank started seeing massive outflows as investors started pulling money for standard operations. This further exacerbated instability in financial markets, with early signs of a liquidity crisis.
By this time, rising interest rates had negatively impacted bond rates, leaving bond-heavy banks like SVB suffering unrealized losses. And the liquidity crisis means they can't even sell their investments to deal with outflows. Things started to deteriorate.
4. March 2023
On March 8, Silvergate Bank had to announce the closure of its business and was unable to meet withdrawal demand. Silicon Valley Bank also announced a $1.8 billion loss as it had to sell some of its bond-only investments to meet increased withdrawal demand. Following the news, SVB Financial, the parent company, was downgraded by Moody's.
On March 9, 2023, SVB's share price plummeted. It also led to $52 million in market value losses for Bank of America, JPMorgan, Citigroup and Wells Fargo. And on March 10, the regulator announced that it had taken over SVB, putting it in the same boat as Silvergate. Furthermore, on March 12, regulators took over Signature Bank, making systemic risk concerns real and legitimate.
However, the regulator announced on March 12, 2023, that customers of the affected banks will get their deposited funds returned. And on March 11 and 12, 2023, some start-ups are also struggling to raise funds to manage day-to-day operations. In addition, a new lending program focused on banks has also emerged, which we will discuss later.
5. The banking crisis will spread outward in 2023, mid-March
On March 15, 2023, the crisis began to spread outward (across the Atlantic), and Credit Suisse's share price hit a new low. Shares in European banks such as BNP Paribas and Deutsche Bank also fell. Although three banks have already collapsed, at this time we see First Republic's credit rating downgraded to "junk" by S&P Global Ratings.
On March 17, 2023, SVB Financial filed for bankruptcy protection. Between March 18 and 27, Swiss UBS completed the acquisition of Credit Suisse Bank. Shares of First Republic unexpectedly jumped 30% on JPMorgan's plans to stabilize First Republic, while the FDIC mentioned that most of SVB's assets would be transferred to First Citizens BancShares.
6. April 2023
April was marked by the near bankruptcy of the First Republic Bank. First, the bank suspended its dividend and mentioned that in March, deposits at the bank fell by about $100 billion. Shares of First Republic Bank began to fall sharply in April.
7. May 2023
On May 1, 2023, regulators took control of First Republic Bank. Then there was a knock-on effect at other regional banks such as First Horizon and PacWest, which reported a 9.5% drop in the value of its deposits on May 11.
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3. The causes of the banking crisis in 2023
The cause of the banking crisis in 2023 cannot be attributed to a single factor. Some experts have even called it a bond crisis, or even a sovereign debt crisis, rather than a real banking crisis.
"Bond crisis, not just a banking crisis. Sovereign debt crisis, not just a bond crisis." Balaji Srinivasan, former Coinbase CTO: Twitter
Let's dig in and understand these reasons better:
1. The global "economic" environment
The global growth rate has slowed down after the epidemic. From cryptocurrencies to stocks, every high-beta asset has entered a bear market phase in 2022. While there were many consequences, the most troubling was the sudden drop in interest rates associated with long-term debt securities, or bonds.
The fall in interest rates on long-term bonds has led to a huge erosion of value in the portfolios of banks like SVB because the bank has significant exposure to these long-term bonds.
For the uninitiated, inflation is often associated with rapid financial growth, driving up the value or interest rates associated with long-term bonds. As the Federal Reserve, European Union and other global institutions began raising interest rates to fight inflation - slowing economic growth in the process - long-term bond rates fell, and so did the value of bank investments. The situation quickly deteriorated when banks had to cash out these investments at losses due to quick withdrawals (also due to rising interest rates).
2. Supervision negligence and obstacles
The 2008 financial crisis led regulators to implement the Dodd-Frank Act, restrict banks' use of investor funds for speculative investing through the Volcker Rule, and create the Financial Stability Oversight Board and the Consumer Financial Protection Bureau.
While we need to detail each aspect of the Dodd-Frank Act separately, you must know that factors such as incompatibility with the Act's verticals (such as the Volcker Rule), insufficient enforcement, and limited space for small banks have contributed to the 2023 U.S. banking crisis.
3. Financial markets and instability
As mentioned earlier, volatility in bond rates makes banks vulnerable. Banks like SVB are heavily invested in long-term, government-backed bonds, and rising interest rates make those bonds less profitable. As banks lose money on their investments, investors quickly withdraw their money, creating a bank run, which is not good for the health of the economy. The banks ended up having to sell these bond investments at huge losses, raising issues with regulators and bankruptcy.
4. Vulnerabilities related to banking
While this is speculation, in hindsight there are multiple vulnerabilities in the banking business through 2023. These vulnerabilities include significant exposure of frustrated banks to speculative investments, excessive risk-taking, and problems related to the freezing of interbank funding. These issues make it difficult for banks to fulfill withdrawal requests. In addition, this even raises the question of "systemic risk", making various threats gradually manifest.
5. Rapid rate hikes and monetary missteps
While we've discussed this before, let's reiterate it here. Since 2022, we have seen interest rate hikes globally to combat inflation.
All of this made borrowing more expensive, dealt a major blow to startups and hit banks even harder as they saw a flurry of withdrawals. While interest rate hikes, driven by the Fed, are partly a response to the threat of "increasing prices," too-rapid and poorly communicated rate hikes are often referred to as monetary policy mistakes. These missteps could be the catalyst for a banking crisis in 2023.
6. Risk management and control failures
Banks operate in risky territory most of the time. This leads to the importance of risk management. During the 2008 financial crisis, one aspect of risk management came under intense scrutiny — assessing the creditworthiness of borrowers. And in 2023, another risk control and management lapse is overexposure to long-term debt securities.
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4. The impact of the banking crisis in 2023
The U.S. banking crisis has had widespread repercussions, not just limited to the national banking sector. Here's how things unfolded.
1. Global economy and influence
Some countries, such as Germany, have experienced negative GDP growth for several months, suggesting that the economy is in recession. Some European banks, including Credit Suisse and Societe Generale, will have to absorb the brunt of a banking crisis in 2023.
That's not all. Here are other areas likely to be affected by this ongoing crisis:
Market Volatility: According to the Merrill Lynch Option Volatility Index (MOVE Index), the bond market remains highly volatile in the wake of the banking crisis.
A credit crunch or tightening: As the credit crunch persists and even banks scramble to find funding, credit crunches on U.S. shores could have repercussions for the global economy, especially for developing countries that rely on external financing.
Business-specific investment falls: Business investment is likely to slow globally as inflation becomes a global concern and the U.S. is expected to take steps to curb spending.
The 2023 banking crisis appears to have a more immediate impact on the U.S. economy than on the global economy. Here are the possible effects:
2. Recession
With banks failing, credit channels clogging and government debt rising, even economists at the Federal Reserve are predicting an imminent recession in the U.S. market. This expectation, or concern, was highlighted at the March monetary policy meeting.
3. Unemployment rate
Unemployment in the U.S. is currently low, which is good news in a banking crisis, right? However, once a credit tightening cycle begins, it typically takes around 14 months for unemployment to peak, the data show.
It is important to note that recessions tend to occur inadvertently after lowest points in unemployment (local bottoms). This is indeed a lagging indicator.
4. Inflation
Although inflation fell below 5% in April 2023, concerns about inflation have not subsided. With the debt crisis looming and money printing appearing to be an option, core inflation may not be out of the woods yet. But this can be a double-edged sword. A banking crisis could reduce people's purchasing power, while rising prices could lead to further declines in consumer spending. This could have a bigger impact on the economy.
5. Rising debt
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5. How have financial institutions been affected?
Although four banks already appear to have failed, the crisis may not be over. Financial institutions may still feel the impact of:
1. Bankruptcy and rescue
Most bank failures were due to shrinking profit margins, loss of deposits and poor risk controls. These factors could worry other remaining banks. Moreover, these concerns could shake investor confidence, putting other banks at risk of failure as well.
2. Resource shortage
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6. Impact on Individuals and Businesses
Assessing the impact on businesses and individuals can be trickier. However, here are some of the most worrisome areas:
Credit in the form of loans is rarely available.
A drop in investment could lead to lower exposure to riskier assets such as stocks and cryptocurrencies.
Uncertainty for businesses is becoming widespread as consumer spending falls.
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7. The role of technology and social media in the 2023 banking crisis
Social media and technology played a role in triggering the US banking crisis. Here are its specific impacts:
The modern era has witnessed the connection of capital between banks across the globe. So when a regional but massive US bank failed, much of the world's financial institutions felt the shock. For the uninitiated, some of the underlying technologies responsible for interbank communication include SWIFT (Society for Worldwide Interbank Financial Telecommunication) and cloud computing.
Also, it’s worth noting that some tech startups such as Roblox and ROKU are affiliated with SVB, causing investors to lose confidence in the industry as a whole. Even cryptocurrencies have drawn the attention of experts, with some citing the exposure of banks to blockchain-based assets as a factor in the crash.
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8. Measures to be taken to solve the banking crisis in 2023
Addressing the negative impact of a banking crisis in 2023 may not be so simple. Multiple agencies—financial institutions, the government and the Federal Reserve System, businesses, and international organizations—need to work together.
Here are some steps that may be underway:
1. How can financial institutions help?
Financial institutions, especially banks, can focus on risk management in the future. Improving liquidity management by diversifying funding sources, holding high-quality liquid assets (HQLA), better forecasting cash flows, and building adequate liquidity buffers are some viable strategies.
The Fed and the government have taken some coordinated steps to minimize the impact of the banking crisis. These include:
2. Rescue plan
Unlike past crisis events, closed banks were not directly bailed out. Instead, the focus is on helping depositors, backed by the Federal Deposit Insurance Corporation (FDIC). One example is the FDIC's use of Systematic Risk Expectations (SRE), focusing on Signature and SVB, to give uninsured depositors a fallback protection benefit. While loan outflows amounted to $400 billion, there was no immediate bank bailout, but measures to protect depositors.
3. Policy changes
One of the most important policy changes amid the ongoing crisis wave was the introduction of the BTFP, or Bank Term Funding Rate. The Fed-led policy focuses on improving liquidity associated with banks, offering one-year mortgages. However, the BTFP is more of a government response to a liquidity crisis than an outright bank bailout.
4. Stress test
The Fed's stress test scenarios for 2023 were released long before the crisis officially surfaced. The set of tests will run from the first quarter of 2023 until 2026, focusing on 28 variables. Although the Fed included so-called "explained market shocks" in its test scenarios, it didn't actually factor in rapid rate hikes. Now, as the fallout from the crisis spreads, new stress tests or scenarios to address vulnerabilities in the capital structure may emerge.
In addition to the solutions above, here are some other approaches that may already be in place:
5. Support from international central banks
Cryptocurrencies Adopted by Individuals and Businesses to Minimize Banking Risk
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9. Lessons learned from the US banking crisis in 2023
The banking crisis of 2023 was not only an eye-opener, it was a reality check, and here are the lessons we learned from it:
1. Financial market and banking reforms are critical
The collapse of the banking sector has exposed regulatory gaps and inaction. As long-term bond rates fell, the concept of asset-liability maturities came to the fore, opening new doors about liquidity management. Another thing everyone has learned is that being overly invested in one industry or sector is never a good thing for a bank as far as investors are concerned. In the end, only serious financial reforms can take all of the above issues out of the equation.
2. Economic resilience is critical
Regardless of the reforms, it all comes down to the ability of banks to withstand shocks such as bank runs. When withdrawal requests start pouring in, everything starts to fall apart, and this is where even banks need to understand - investing in just one asset class is not a good practice. We also need to note that the introduction of BTFP is a step towards establishing economic dependence.
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10. Economic recovery after the US banking crisis
It remains to be seen what else the government, the Fed, and policymakers can do to boost the recovery, but here are ideas that may already be brewing:
Strengthening the banking space
more cautious in raising interest rates
Restoring confidence in the banking system
Stimulate economic trends through relevant fiscal policies
International cooperation for overall financial stability
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11. Crisis or cure: What is the long-term outlook?
Regardless of the approach, it all boils down to building a strong financial system. The worst of the 2023 banking crisis may or may not be here yet. It is worth noting that as of the end of May-early June 2023, financial market stress has not eased, and credit spreads remain tight. While rate hikes are still on the way, the Fed does appear to be wary of such moves. However, the U.S. banking crisis in 2023 is a highly complex space that encompasses issues such as bond rates, interest rates, lines of credit, and bank runs.
