Bank Failures Shine Light on Interest Rate Risks

Financial markets reacted turbulently to the collapse of Silicon Valley Bank (SVB) on March 10, 2023, followed two days later by the failure of Signature Bank of New York. With $209 billion in assets and $175 billion in deposits, SVB was the nation's 16th-largest bank and the second-largest to fail in U.S. history.

This news alarmed many savers, who worried that their own bank accounts could be at risk. It also concerned investors, who feared the possibility of a broader financial crisis. To restore confidence in the U.S. financial system, the federal government pledged to make all depositors whole. It also committed to supporting other banks that might face liquidity problems caused by rapidly rising interest rates.

These events have renewed attention on how banks operate and how they earn money from customer deposits. They have also highlighted the risks banks take and the important role the government plays in regulating and supervising the banking system.

What is the FDIC?

The Federal Deposit Insurance Corporation (FDIC) is an independent agency backed by the full faith and credit of the U.S. government. FDIC insurance is intended to reassure depositors and offer protection in case an insured bank becomes insolvent, is liquidated, or experiences other financial difficulties. Most banks in the United States are insured by the FDIC, which protects deposits up to $250,000 (per person, bank, and account category).

When a member bank fails, the FDIC issues payments to depositors (typically up to the limits provided by law) and takes over the administration of the bank's assets and liabilities. Generally, the FDIC will try to arrange for a healthy bank to take over the deposits of a failed bank. If no bank assumes that role, the FDIC taps a fund that is financed by premiums paid by insured banks.

Why are banks under pressure?

In its effort to control inflation, the Federal Reserve raised the benchmark federal funds rate from near zero to more than 4.5% in just over a year. Banks typically earn money by investing customer deposits in relatively safe assets, such as long-term U.S. Treasury securities and other government-backed bonds. U.S. Treasury securities are backed by the full faith and credit of the federal government for the timely payment of principal and interest.

However, when interest rates rise, the market value of existing bonds falls. This creates problems if banks are forced to sell bonds before they mature. By the end of 2022, U.S. banks had recorded approximately $300 billion in unrealized losses on bonds they intended to hold to maturity.

At Silicon Valley Bank (SVB), weak balance-sheet management made the situation worse. SVB focused heavily on technology start-ups and was knowingly exposed to risks in that volatile sector. As start-up valuations declined and venture capital funding slowed, customer withdrawals increased. This pressure forced SVB to sell $21 billion in securities at a $1.8 billion loss.

More than 90% of SVB’s deposits were uninsured, making customers more likely to panic and withdraw funds once the losses became public.

Signature Bank faced similar challenges. A large portion of its deposits were uninsured, and the bank was also a major service provider to high-risk cryptocurrency businesses, which increased its vulnerability during market stress.

What actions did the government take?

In a joint statement, the U.S. Treasury, the Federal Reserve, and the FDIC said that depositors of SVB and Signature Bank would have full access to their money. Regulators concluded that the bank failures posed a risk to the broader financial system. This determination gave the FDIC greater flexibility to protect deposits that exceed the $250,000 insurance cap. Any losses to the FDIC insurance fund will be recovered through a special assessment on banks.

The banks’ shareholders and unsecured bondholders did not receive government support. To address liquidity concerns, the Federal Reserve introduced a new facility called the Bank Term Funding Program (BTFP). This program helps ensure banks can meet depositors’ needs without selling bonds early. Under the BTFP, banks can borrow one-year loans using government bonds as collateral.

During the week ending March 15, fragile U.S. banks borrowed a combined $164.8 billion from the BTFP and the Federal Reserve’s discount window. The discount window is a long-standing liquidity backstop. This borrowing level exceeded the peak seen during the 2008 financial crisis.

How will other banks be affected?

Moody’s Investors Service downgraded its outlook for the entire banking sector from stable to negative, citing a “rapidly deteriorating operating environment.” Lower credit ratings can raise borrowing costs and reduce earnings.

First Republic Bank (FRB) was one of five banks placed under review for potential rating downgrades. The action reflected substantial unrealized losses and exposure to deposit outflows from uninsured customers. Despite a $30 billion rescue package from a group of the nation’s largest banks, FRB’s credit rating was later downgraded to junk status.

The situation remains fluid, and it is too early to determine whether additional banks will face similar distress. Regulators have emphasized that the U.S. financial system remains resilient and rests on a strong foundation. This strength is due in part to safeguards implemented after the last financial crisis.

The Federal Reserve has launched an internal review to assess what went wrong and whether warning signs were missed. The findings may lead regulators to place greater focus on smaller institutions and strengthen oversight requirements.

Are your savings protected?

If you have multiple accounts at the same bank, review each account carefully. Check who is listed as the owner, which ownership category it falls under, and whether it overlaps with other accounts that could affect how much is insured. Common ownership categories include individual accounts, joint accounts, retirement accounts, trust accounts, and business accounts.

You cannot increase FDIC coverage by holding different product types—such as checking, savings, or CDs—within the same ownership category. All accounts in the same category at one bank are combined for insurance purposes. An online tool available at FDIC.gov can help you estimate your total FDIC insurance coverage.

If some of your funds are not fully insured, you may want to restructure your accounts to increase coverage. For example, a married couple could increase total coverage at one bank to up to $1 million by holding one joint account plus two individual accounts. If you regularly maintain balances above $250,000 in personal or business accounts, it may also make sense to spread funds across multiple financial institutions or reconsider your overall cash-management strategy.

All investing involves risk, including the possible loss of principal.
1) Reuters, March 13, 2023
2) Federal Deposit Insurance Corporation, March 12, 2023
3-4, 8, 12) Federal Reserve, March 12, 2023
5-6) Bloomberg, March 12, 2023
7) The Wall Street Journal, March 14, 2023
9) Bloomberg, March 16, 2023
10) CNBC, March 14, 2023
11) Reuters, March 19, 2023
13) The Wall Street Journal, March 14, 2023

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