US President Joe Biden on Monday sent a message of calm about the solidity of the banking system after the failure of two banks, Silicon Valley Bank (SVB) and Signature, in three days. “Rest assured: the banking system is sound, your deposits are safe” and “they will be available when you need them”, he assured in a brief statement in the Roosevelt Room of the White House, before embarking on a trip to California. The head of state also announced the resignation of those responsible for SVB and called for stronger regulatory measures for the sector.
Biden was speaking after US financial officials announced on Sunday that they would insure all deposits at the SVB, whose failure on Friday threatened to topple other regional financial institutions and create a crisis of confidence in the country’s banking system. In the event of a bank failure, regulators cover deposits of up to $250,000, but 96% of the California bank’s funds exceeded that threshold and were unsecured. A disaster for its customers, mostly companies in the technology sector — many of them startups — who needed access to that money to make their own payments.
The Federal Reserve and Treasury Department have indicated that, in addition to supporting SVB deposits, they will create a new lending facility for banks that may be hit by a wave of withdrawal demands from their customers.
The problems at SVB, the 16th largest bank in the United States, stemmed from its investment decisions. The bank placed more than half of its deposits in fixed-income government bonds, considered low-risk compared to new loans. But the rise in interest rates, forced by rising inflation, caused these bonds to lose value, while the technology sector entered a period of scarcity. A perfect storm: As its customers began to withdraw deposits to meet their obligations, the entity was forced to sell its bonds at a loss of around $1.8 billion.
Venture capital investors’ recommendation to startups to withdraw their deposits from the bank was the last straw. On Thursday, SVB customers withdrew $42 billion in ten hours, the biggest deposit drain by a financial institution in the United States in recent times: until now, the record was held by Washington Mutual in 2008, with 16.7 billion dollars in ten days.
The new mechanism implemented by the Fed and the Treasury seeks to avoid the repetition of these events. Rather than being forced to sell their bonds at a loss, banks that need it will be able to borrow from that body and use those bonds at their original value as collateral.
In his brief speech, Biden wanted to send Americans a message of calm about one of the greatest concerns of citizens since the global financial crisis of 2008. “Taxpayers will not have to assume any kind of damage,” he emphasized. The cost of these operations will be covered by fees that banks pay to regulators. There will be no bailout for the bank’s investors either: “They made a bet knowingly and lost it. Capitalism is about that,” she emphasized.
Yes, he will ask Congress for tougher control measures over the banking system, to prevent this type of problem from happening again in the future. After the 2008 crisis, the US government undertook a broad reform of the sector that included greater oversight of regulatory bodies, in the so-called Frank-Dodd law, by the senators who drafted it. But during Donald Trump’s term (2017-2021), part of these provisions were overturned, recalled Biden.
Despite messages of calm from US officials, markets reacted nervously on Monday. Investors remain concerned that the contagion from the SVB will spread to other smaller and regional banks. Another bank with problems similar to those of SVB, First Republican, with a client base made up mainly of very wealthy companies and depositories, saw its share price drop 60% after several days of consecutive declines. Not even banking giants like Wells Fargo or Bank of America were saved, which also recorded declines in their bonds.
The uncertainty surrounding the sector could also affect the decisions of the Fed, which will hold its monthly meeting next week to decide on interest rates. Until now, it was taken for granted that he would announce another increase, in line with his strategy to combat inflation. But events may force him to change his mind and suspend further hikes, at least for now, given signs of pressure that high rates are putting on banks’ books.
“Right now, the problem has more to do with interest rate risk than credit risk, and the State can probably better manage and contain it for that reason,” says the chief economist for markets by Capital Economics consultancy, John Higgins. His colleague Paul Ashworth, chief economist for the United States at the same consultancy, declares, in turn, that the events of recent days “will have lasting effects. They will certainly make banks less willing to grant new loans, for example”, something that increases the risk of deterioration in economic conditions throughout this year. “That reduces the chances that the Fed will raise rates for the remainder of the year and increases the likelihood of cutting rates,” says Ashworth.
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