Many other lenders are also sitting on unrealized losses caused by rapidly rising interest rates.
Nearly 200 U.S. banks face risks similar to those that led to the implosion and bankruptcy of Silicon Valley Bank (SVB), according to an article published this week on the Social Science Research Network. SVB, a major US lender focused on the tech and startup sectors, was shut down by regulators last week after massive deposit outflows.
In the study, four economists from leading US universities estimated the market value of assets held by US banks due to recent interest rate hikes.
“From March 07, 2022 to March 6, 2023, the federal funds rate rose sharply from 0.08% to 4.57%, and this rise was accompanied by quantitative tightening. As a result, long-lived assets similar to those held on bank balance sheets experienced significant declines in value over the same period,” they wrote.
Although higher interest rates may benefit banks by allowing them to lend at a higher rate, many US banks have placed a significant portion of their excess cash in US Treasury bonds. This was done when interest rates were at levels close to zero. The value of these bonds has now fallen significantly due to rate hikes – investors can now simply purchase newly issued bonds that offer a higher interest rate. The decline in the banks’ portfolios has not been realized, which means that the value of the securities has decreased but that the loss is still only “on paper”.
The problem arises when customers demand repayment of their deposits and banks are forced to sell their securities – at a significant loss – in order to reimburse depositors. In extreme cases, this can lead to bank insolvency or, as happened with Silicon Valley Bank, loss of confidence can trigger a bank run.
The report’s authors looked at the amount of funding US lenders come from uninsured deposits: the larger the share, the more likely a bank is to make a run. For example, at SVB, where 92.5% of deposits were uninsured, the outflow of deposits caused the bank to collapse in just two days. The study’s authors calculated that 186 US banks do not have enough assets to pay all customers if even half of uninsured depositors decide to withdraw their money.
“Our calculations suggest that these banks are certainly at potential risk of a run, absent further government intervention or recapitalization… Taken as a whole, these calculations suggest that the recent declines in the value of bank assets have very significantly increased the fragility of the American banking system in the face of the rushes of uninsured depositors.“, the economists concluded, noting that the number of banks at risk could be”significantly“bigger if”uninsured deposit withdrawals even cause small sell-offs.”
SVB’s failure had repercussions for the entire US banking industry and caused the closure of another lender, Signature Bank. Many other financial institutions saw their stocks plunge, with Wall Street’s six largest banks losing about $165 billion in market capitalization, or about 13% of their combined value. Earlier this week, ratings agency Moody’s downgraded its outlook for the US banking system from “stable” to “negative”, citing the “rapidly deteriorating operating environment.”
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