Notes on SVB and the Status of the Banking System
The failure of SVB brought to the forefront the topic of bank failures and whether or not your savings are safe sitting in an account in a bank. We wanted to explain how the system works to help better inform our clients, including the difference between banks and broker-dealers and the various protections that are in place for their customers.
We also wanted to announce a cash management account option that we have selectively implemented for clients recently.
How a bank works and what happens when it fails
ELI5 (Explain it like I’m 5)
- Banks take deposits from customers
- They make loans with those deposits
- The difference in interest rates they charge on the loans and the interest they pay their customers is their profit
- Banks deposits (liabilities) are available on demand, while loans (assets) are longer term, which creates an asset and liabilities mismatch
- One of the bank’s main jobs is managing that mismatch
- If a bank fails, the FDIC insures up to $250,000 of an account
Most people have a relationship with a bank for a checking account. People also have savings accounts and may have gotten a mortgage from their bank. The business model of a bank is fairly simple. You deposit your money into an account that you use to pay your bills (checking account) or for longer-term savings (savings account), the bank then uses that money to make loans (e.g. mortgages). If they do not make enough loans, they can also use the money to buy debt securities like US government and corporate bonds and mortgage bonds (important for later.) The difference between what the bank charges to make loans and what they pay you on your money is their profit. That's it. It's pretty simple. Your deposits at a bank become their liabilities, which are short term i.e. you can go in anytime and ask for your money back and they have to give it to you. The loans they make with your money however are longer term, e.g. that 30-year mortgage. Because most people choose to leave their money in a bank for long periods of time, banks will also make more loans than the money in their client accounts. This is referred to as leverage. A conservative leverage ratio may be 10 to 1, meaning for every $1 in a bank’s checking account, they make $10 in loans. Government regulators are in charge of making sure that banks' leverage levels don’t get too high. Beginning in 1934, a government agency was founded to also provide insurance for client accounts in the event a bank goes bankrupt. This is the FDIC, you may be familiar with this plaque which banks are required to display at their branches.
Since the financial crisis of 2008, the amount of insurance the FDIC provides is $250,000 per account. So simply put, if you have $250,000 or less in a bank account, this is protected by the government. However, if you have more than this amount and the bank goes bankrupt, well, this is what happened on Friday with SVB.
How did SVB fail?
ELI5
- SVB worked with start-ups and founders
- They grew rapidly post-pandemic
- Instead of making loans, they used those deposits to buy bonds
- As interest rates rose in 2022 and beginning of 2023, the value of those bonds fell
- A few market participants started noticing over the last 3-4 months
- A few VCs began to suggest their companies move their cash out of the bank
- As this trend accelerated, the bank was forced to sell some of their bonds at a loss
- This caused more customers to move funds out
- A run on the bank ensued, and the FDIC had to step in
SVB is somewhat unique in that they are a preferred banking partner for start-up companies and their founders and employees. They experienced rapid growth recently, given the significant growth of the venture capital and start-up ecosystem over the last decade. Given the scale of growth they experienced, instead of making loans, they instead bought securities, including US government and mortgage-backed bonds. Mortgage-backed bonds are exactly as they sound, they are created when a bunch of mortgages are pooled together and sold as securities through a process called securitization. Long-dated US government bonds and mortgage-backed bonds are highly sensitive to interest rates. As interest rates rise, the value of the bonds fall, and vice versa. Normally, if a bank’s client account balances stay steady, there is no issue. However, a few market participants started to take notice of the losses on their bond portfolio late last year. As some VCs advised their companies to move cash out as a safety measure, the bank was forced to sell some of their bond portfolio at a loss. This spooked the market and precipitated a classic bank run last week. The FDIC was forced to step in on Friday in order to facilitate an orderly winddown.
What happened over the weekend?
ELI5:
- There was a lot of panic in the VC and start-up community because many had cash at SVB they were not able to access
- The FDIC attempted unsuccessfully to sell SVB
- Signature Bank was also taken over by the FDIC
- The government (Treasury, Federal Reservce, FDIC) announced Sunday night that the FDIC would cover all deposits, not just up to $250,000
- The measures taken were designed to stop the panic and prevent additional bank runs
There was a lot of uncertainty about customers of SVB who were not able to get their cash out before the bank was shut down. The lack of access to any more than $250,000 of capital on Monday morning, put in jeopardy the ability to make payroll for many companies. Prominent VCs and other market participants started to make a lot of noise on social media for the deposits at SVB to be backstopped by the government. There was speculation of many additional bank runs when they opened for business. It was reported that the FDIC attempted to sell SVB, something they would typically do, however, they were not able to reach an agreeable deal. On Sunday, the FDIC announced that they were taking over Signature Bank, another regional bank that had been rumored to be under pressure. On Sunday night, the government announced that the FDIC would be insuring ALL bank deposits, not just up to the $250,000 limit. In addition, the Federal Reserve provided a new emergency facility for banks to be able to borrow using their securities as collateral at par (even if their value is down due to the interest rate rise.) So far, this has calmed some of the panic, although bank stocks continued to be under heavy pressure on Monday, before rebounding somewhat on Tuesday. While a lot is still unknown, there are concerns that this has created a moral hazard, disincentivizing banks from prudently managing their balance sheets going forward.
Is my money safe? What can I do?
The short answer is yes. If you have money at an FDIC-insured bank, up to $250,000 of the account is protected by the government (this may go up after the recent incident). If you have over $250,000 at a bank, you should consider opening an additional account at another institution. Some banks are also able to make more than $250,000 insured, you should inquire with your bank about this. One other thing you can do is open an investment account with a broker-dealer and invest it in securities. Even in the event of a failure of a broker-dealer, any securities held in an account in your name are yours. Cash is not treated the same way in the event of bankruptcy.
Centerfin recently began offering our clients accounts solely for the purpose of providing higher interest than you can receive at a bank. We do this by investing in short-duration securities that provide an interest rate closer to what the current federal reserve funds rate is. Our client accounts are held with Goldman Sachs Advisor Solutions (fka Folio Institutional) We would be happy to help; opening an account takes 3 minutes!
