What causes a bank to fail?
Within the last week, two United States banks have collapsed, and that seems alarming- especially because we think of banks as being a safe place for money. Choreo Financial Planner Michelle Buria explains how this happened and why our local banks are likely safe.
Michelle tell us that Silicon Valley and Signature Banks focus on loaning and accepting deposits from Tech Start-Ups: “They were very focused and not diversified. With this influx of cash, they almost doubled their deposits during the pandemic. So they took that cash, and they invested it in long term securities.”
Meanwhile those who deposited their money, earned interested at a short term rate.
“That strategy only works when you long term rates are higher than your short term rates.
“When the Fed started raising interest rates, the banks had to start raising the deposit money what they were paying to their consumer because they to stay competitive.
“In a quick amount of time, the short term rate was all of a sudden more. So they were paying out more to their consumer than they were earning on their investment income.
“The second piece is when the funding stopped. They had to rely heavily on the cash they had on hand at these banks. And when they ran out, they needed withdraw money and sell long term investments at a loss.”
It sounds concerning, but this isn’t 2008, Michelle says, “We are not in the same environment that were back then.”
Protections have since been enacted, requiring banks to have a higher level of capital for situations like this.
Recently, the Fed put in a new program called the Bank Term Funding Program. They’re guaranteeing protections above the FDIC amount. “It’s also a program for the future. So if a bank comes across something like this, they can take a short term loan to help with those cash transactions.”