Recently, Silicon Valley Bank, an important financial intermediary in one of the most important industrial centres of the world failed. Depositors queued demanding withdrawals.
Within the same week other banks in the USA, including Signature Bank, and Silvergate Bank also failed and have since put immense pressure on more banks, including Credit Suisse, and First Republic Bank. One large bank failure even in isolation is a serious problem to the wider economy. Multiple bank failures, in such a short time, has always meant recession or depression.
Looking back, the great depression in 1929 was the most intense economic downturn of the 20th century caused by a sharp drop in the stock market leading to bank runs, forcing the economy to grind to hold. In 1986, savings and loans associations focusing on consumer savings and consumer loans experience came into question during rising interest rates.
In 2008 banks that facilitated and encouraged new types of investment were put under pressure when the value of those investments failed. The market panicked eventually resulting in the greatest bank in the US history Washington Mutual failing and kicking off the economic recession.
In 2023 after three years of unprecedented economic turbulence kicked off by Covid-19 and further exacerbated by tensions and the Russia-Ukraine crisis, the developing market debt crisis, and the hangover from the stimulus measures meant to fight these shocks, the economy was in an uncertain position.
Pertinent questions
Economists are asking pertinent questions: What is causing these most recent bank failures? Why was the government unable to stop it? Are more bank failures likely to follow? Will these bank failures cause wider economic problems?
The 2023 bank failures have all had some things in common. All failed banks were involved in providing financial services for niche markets, rather than everyday consumers. Silvergate and Signature did a lot of their business with cryptocurrency exchanges and investors and Silicon Valley Bank focused on providing services to the types of businesses that make Silicon Valley the global centre of innovation. The banks also had very large account sizes.
According to American Bankers Association statistics, “the average bank account size and the average bank in the USA was $41,600 as of 2019”. However, this figure is an average and skewed by the enormous accounts by companies and high net-worth investors. In this case, the average account balance for Silicon Valley Bank was over $1 million and a lot of their services were not available to people or companies that had less than that amount.
The problem created for the banks is that the depositors’ money was mostly not covered by the Federal Deposit Insurance Corporation (FDIC), which guarantees the first $250,000 per depositor per insured bank, for each account ownership category.
The FDIC was first introduced in 1934 as a response to the economic problems, caused by bank failures during the Great Depression. But when most accounts held at the bank would not be covered by this limit, it introduces the risk of bank runs.
The solution to this problem would just be to remove the limit for any amount of money to be covered, which means even very wealthy account holders would have no real need to rush their money out of the bank.
There is a trade-off when you insure deposits. On the one hand, if deposits are uninsured, there is going to be a lot of bank runs because depositors are going to react strongly each time there is a signal that the bank might not be doing too well. That has generated a lot of banking panics for instance in the early 1930s in the US which is why the FDIC was introduced.
Moral hazard
There is definitely an argument for the problems of moral hazard in the banking sector. While the FDIC has stepped up to try and make sure that nobody rushes to take their money out of any more banks by ensuring that everyone will be covered in theory, it should have never got to this point because it is the Federal Reserve’s job to make sure that this never happens.
Silicon Valley Bank had enough assets to cover its deposit. However, they had not planned a contingency for the possibility of an unprecedented amount of withdrawals.
The Federal Reserve Bank is supposed to act as a lender of last resort in the situation. If any bank gets in trouble and they do not have enough cash to cover withdrawals, they can request central bank to get a short-term loan so they can pay the withdrawals of the depositors.
The central bank does this because it knows if just one person cannot get their deposits out of the bank on demand, it can start a panic that could cause bank runs on multiple banks and stress the entire financial system.
How is the banking sector faring in Kenya? The banking sector in Kenya is strong compared to the past when Imperial Bank and counterparts failed.
Today the banks hold strong capital bases and have sufficient liquidity positions in place, the banks are performing well, are supporting loans and safeguarding depositors while also keeping shareholders satisfied with decent dividend payouts.
