Ask the Rational Investor: Is a banking crisis looming?
Recent weeks have been reminiscent of the Great Financial Crisis when bank stock prices declined dramatically day after day. In 2008, the banking crisis was related to loans that were underperforming, causing banks to lose money and investors wondering when the loses would stop.
Silicon Valley Bank and Signature Bank failed recently due to a lack of liquidity as depositors worried about the banks having enough cash to give them their money back.
These collapses remind us of the Great Financial Crisis, but investors should not worry as banks remain well capitalized and credit quality remains strong. Let’s examine how banks function and why recent bank failures are likely not the beginning of another crisis.
On the asset side of a bank’s balance sheet are loans and securities. Loans usually consist of residential or commercial mortgages. When banks have more liquidity than they can lend they often purchase securities that are generally low risk and consist of US government bonds, municipal bonds, or mortgage-backed securities.
On the other side of the balance sheet are banks liabilities, which include a mixture of checking, savings, certificate of deposits, and various forms of debt. Banks depend on having lots of low-cost deposits.
Silicon Valley Bank and Signature Bank had similar issues that caused them to fail. Both banks had depositors that were large and concentrated and were well above the FDIC insured limit of $250,000. Once these depositors became concerned millions upon millions of deposits were withdrawn almost instantly.
Large and concentrated depositors are not common for the average bank as most deposit accounts are under $250,000. Silicon Valley and Signature uniquely focused on lending to venture capital backed and cryptocurrency companies that maintained very large account balances.
As stock prices declined a vicious feedback loop occurred causing more deposits to leave and stock prices to decline further until the government regulators seized the institutions.
The risk of future deposit runs on more traditional banks is remote and stock prices of high-quality institutions should continue to recover over the next few months.
Sources: Factset
Beese Fulmer Private Wealth Management was founded in 1980 and is one of Stark County’s oldest and largest investment management firms. The company serves high-net-worth individuals, families, and non-profits, and has been ranked as one of the largest money managers in Northeast Ohio.
This article originally appeared on The Repository: Ask the Rational Investor: Is a banking crisis looming?
