Many businesses in the United States are still reeling from the 2008 financial meltdown in the country that was triggered by scrupulous banking practices, including cheap credit and lax lending standards. Recent news from the banking sector indicates that we may be on the cusp of another financial crisis.
As of May 2023, several banks including Silvergate Bank, Silicon Valley Bank, First Republic Bank, and Signature Bank tanked due to financial pressures triggered by the massive withdrawals and losses due to the sale of the Treasury bond portfolio at a great loss to cover said withdrawals.
The trouble in the banking sector has raised concerns from policymakers and investors about the health of the financial system, which we will look into in great detail..
In March 2023, New York-based Signature Bank and Californian-based Silvergate Bank ceasedoperations. These banks had invested a significant amount in long term assests. The recent bank run forced the banks to close operations this year.
Silicon Valley Bank based in Los Angeles; CA also closed the same month. The bank was forced to close down after it experienced losses amounting to $1.8 billion on the sale of mortgage-backed securities and US treasury bonds.2 The loans and deposits of Silicon Valley Bank were purchased by First Citizens, which changed its name to Silicon Valley Bridge Bank.
In addition, First Republic Bank (FRB) which is based in San Francisco, is another bank that closed operations. The bank had reported dismal results during Q1 2023 including a decline of $100 billion in deposits. It was sold to JP Morgan Chase Bank on May 1 this year.
PacWest Bancorp – a mid size regional lender based in Beverly Hills, CA – has also reported financial distress as it plans to sell a loan portfolio of nearly $2.7 billion to investors and partners.1
The large bank losses and failures have prompted depositors to withdraw their cash. The failure of the banks has hit shares of other banks with some banks such as Fifth Third Bancorp and Western Alliances trading at a significantly lower value as compared to the start of the year.
Experts have blamed neglect in identifying financial problems for the failure of the three banks. Additionally, the rollback of regulations regarding the banking sector during the Trump administration is also to blame for the current crises.
The Dodd-Frank banking regulation was rolled back during the Trump administration in 2018.3 The law eased rules on small and mid-sized banks to boost economic growth. But the lack of oversight of these banking firms made them more susceptible to making bad financial decisions.
With the rollback of the Dodd-Frank Act, banks with a capitalization of less than $250 million were not required to undergo stress tests and mortgage loan reporting requirements to prevent a financial meltdown. It is the same reversal of the regulation that is largely blamed for the banking crises that experts say will worsen in the months ahead.
The Federal Reserve’s persistent rate hikes have also contributed to the recent wave of bank failures.
In May 2023, the Federal Reserve increased its interest rates to up to 5.25 percent, pushing the rate to its highest level in over 15 years. This decision, coupled with the ongoing banking crisis, is likely to potentially worsen the situation, with the potential for a serious credit crunch.
Banking crises can have a significant impact on the economy, and the effects can be long-lasting. As fear of a banking crisis spreads, businesses and consumers will begin withdrawing their money from smaller and mid-sized banks. This will create a self-fulfilling prophecy, as increased withdrawals will worsen the banking crisis.
Here are some ways that banking crises can impact the economy in the months ahead.
Credit crunch: During a banking crisis, banks may become more hesitant to lend money, leading to a credit crunch. This can make it difficult for businesses and individuals to obtain loans, which can slow down economic growth.
Job losses: Economic downturns caused by banking crises can lead to job losses, as businesses may struggle to stay afloat and may need to reduce their workforce. This can lead to a rise in unemployment and a decrease in consumer spending.
Reduced economic activity: Banking crises can lead to a reduction in economic activity, as businesses may be less willing to invest, and consumers may be less willing to spend. This can lead to a decline in GDP and a recession.
Government bailouts: In some cases, governments may need to bail out banks to prevent a complete collapse of the financial system. This can lead to an increase in government debt and may result in higher taxes or reduced government spending in other areas.
Loss of confidence: A banking crisis can lead to a loss of confidence in the financial system and the economy as a whole. This can lead to a decrease in foreign investment and a decline in international trade.
To sum up, the banking crises can have a significant impact on the economy and can lead to a range of negative effects, including reduced economic activity, job losses, and a decline in consumer confidence.
The current US banking crisis has the potential to disrupt the economy similar to the 2008 financial meltdown. The government needs to act fast to prevent a repeat of the financial meltdown. It needs to learn from its mistakes in the past to prevent a catastrophe.
Businesses and consumers are advised to avoid making hasty decisions, and taking out money from local regional banks as it could worsen the crisis. All deposits in banks are federally insured. The Federal Reserve has also enacted the Bank Term Funding Program that will safeguard all bank deposits.
So, the best action to take in the current scenario is to remain vigilant but avoid panicking. Avoid making hasty decisions such as taking out deposits or selling shares, especially of local small and mid-sized banks as it will worsen the crisis.