concept of back sitting in a flooding lightening and thunder storm

Regulators’ seizure of First Republic Bank on 1 May and its quick sale to JPMorgan Chase for $10.6 billion marked a new chapter in the U.S. banking crisis, not its end.

After Signature and Silicon Valley banks collapsed in mid-March, deposits flew out of small and regional banks into megabanks and money market funds, which people considered safer.

Many of those migrating deposits exceeded the $250,000 insurance limit set by the U.S. Federal Deposit Insurance Corp. (FDIC).

Now a study has found 186 U.S. banks that are liable to fail if just half of their uninsured deposits leave, USA Today reported.

The reason: small and regional banks are at special risk from the U.S. Federal Reserve’s steady rise in interest rates.

Most bonds pay fixed interest rates. When interest rates fall, those fixed rates become attractive and bond prices rise. 

In contrast, when rates rise, investors turn their backs on fixed-rate bonds and their prices fall because fewer investors are interested and the market for them shrinks. 

Banks bought government bonds in 2020 and 2021 when banks were flooded with COVID-era deposits, demand for loans tanked, and banks bought government bonds at 1 or 2 percent interest as a way to make a safe return during the economic shutdown. 

The Fed has taken its key rate from 0.25 percent to 5.25 percent over the past 14 months. If banks now have to sell low-yield assets to raise cash when depositors demand their money back, those banks are unlikely to find willing buyers for bonds paying far lower returns than newer issues.

So far, banks’ losses on those bonds—amounting to around $6240 billion, as we reported in “Lax Oversight Allowed Banks to Fail, Experts Say” (28 Mar 2023)—remain on paper.

However, Silicon Valley Bank is a harbinger: it collapsed, in part, because it was unable to raise cash after failing to find buyers for its bonds paying fractional interest rates when investors could buy newer bonds paying returns several times higher.

“The recent declines in bank asset values significantly increased the fragility of the U.S. banking system to uninsured depositor runs,” according to the new study economists have posted on the Social Science Research Network.

If runs multiply across many banks, even insured depositors might not be covered if the FDIC begins to run out of money, the study warned.

“Our calculations suggest these banks are certainly at a potential risk of a run,” the study authors wrote.

Should such a surge occur, Congress or the Fed would likely step in to bail out depositors, USA Today noted.

TREND FORECAST: The three recent rapid-fire failures have spooked small and regional banks to put their affairs in order.

However, bank failures are not over.

Instead of collapsing outright, some teetering banks will be bought by rivals, sometimes with regulators’ help.

More broadly, faith in small and mid-size U.S. banks has been damaged and will take time—and possibly publicly advertised regulatory reform—to recover.

As a result, megabanks will become even more “mega,” wielding even more power in the financial and political worlds.

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