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🔻🏦Will more banks fail?

published17 days ago
5 min read

Welcome to Nonrival, the newsletter where readers make predictions about tech, business, and the economy.

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In this issue

  • Forecast: In the wake of Silicon Valley Bank, will more banks fail?
  • I'm sending this one early because a lot could change between now, as I finish writing, and tomorrow morning!

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​Will more banks fail?​

On Friday, Silicon Valley Bank was taken over by federal authorities in the biggest failure of a US bank since the 2008 financial crisis. SVB, which caters to tech startups and VCs, seems to have misjudged the risk of rising interest rates. Then, when it announced it had sold some bonds to improve its financial position, the tech world panicked and depositors started asking for their money back. That caused a classic bank run, forcing the regulators to step in.

SVB’s shocking unraveling raises two big questions:

  1. Will a wave of tech startups that banked with SVB be forced into bankruptcy—or at least layoffs—due to an inability to access their accounts?
  2. Will SVB’s failure ripple through the banking sector, taking others down with it?

This week’s forecast is about the second question:

  • Will another of the 50 largest commercial banks in the US will fail in 2023?

Background

Here’s the basic story, via the Times’ Dealbook:

“The failure of Silicon Valley Bank was caused by a run on the bank. The company was not, at least until clients started rushing for the exits, insolvent or even close to insolvent. But if the banking business is ultimately a confidence game, the game ended quickly.
​
The collapse may have been an unforced, self-inflicted error: The bank’s management chose to sell $21 billion of bonds at a $1.8 billion loss, in large part, it appears, because many of those bonds were yielding an average of only 1.79 percent at a time when interest rates had risen drastically and the bank was starting to look like an underperformer relative to its peers. Moody’s was considering downgrading its rating. The bank’s management — with the help of Goldman Sachs, its adviser — chose to raise new equity from the venture capital firm General Atlantic and also to sell a convertible bond to the public.
​
It isn’t clear if the bond sale or the fund-raising, at least initially, had been made under duress. It was meant to reassure investors. But it had the opposite effect: It so surprised the market that it led the bank’s very smart client base of venture capitalists to direct their portfolio clients to withdraw their deposits en masse.”

Indicators

More than 500 US banks have failed since 2001, most in the years immediately following the crisis of 2008-2009.

But most of those failures are smaller banks. SVB is not massive, but it’s not small either. The chart below shows annual bank failures but by total assets: SVB is the only failure so far this year but it’s a big one. Only 2008 has a higher level of total assets among failed banks.

​At Quartz, Scott Nover and Clarisa Diaz pulled together the biggest bank failures by assets broken out by the actual failure not the yearly total:

(Seven of these would clear the threshold for today's top 50 banks by assets, the metric for this week's forecast.)

Perspectives

What happens now?

The FDIC has three options. The most common resolution is to find a buyer to take over the bank’s assets and liabilities. If there’s no buyer, the FDIC can handle payouts to depositors itself or it can set up a new temporary bank with its own charter, giving depositors time to move their money to another bank. The worry, if there’s no buyer soon, is timing: Almost by definition, most startups don’t bring in enough money to cover their costs and need access to the funds they’ve raised to make payroll.

Forecasters on Manifold Markets give a 63% chance of another bank buying SVB by this coming Saturday.

“This weekend is everything”

“The FDIC said only that those in excess of $250,000 [the limit on FDIC insured deposits] will receive ‘an advance dividend within the next week.’... One big reason this weekend matters so much is that the next pay period for many companies is next Wednesday, March 15. The best-case scenario is that another financial institution steps up and agrees to buy SVB, thus automatically strengthening its balance sheet. Such a purchase presumably would facilitate the reopening of client accounts, and also calm nervous investors who've been dumping shares of SVB rivals like First Republic and PacWest.” —Dan Primack, Axios, March 10​

The case for contagion

The problem at SVB was misjudging interest rate risk. Could other banks have that issue, too?

“Underlying the failure was a demonstrable problem, one to keep an eye on for other banks: The company had invested its deposits in low-interest rate bonds that it held on its books on a long-term “hold-to-maturity” basis. That means that it did not have to mark-to-market those bonds until they were sold, leaving investors with a somewhat distorted view of its balance sheet. So long as a bank doesn’t need to sell “hold-to-maturity” assets to meet withdrawal requests, there is no problem. But if a bank has to sell at a loss, that’s when things get complicated.” —Dealbook, March 11​

The case that other banks are fine

It’s essentially that SVB, while fairly large, is very niche.

“In the past few years, plenty of other banks received waves of deposits and put the money to work in long bonds. Might they face the same fate as SVB? Possibly, but SVB was an outlier in the banking industry, in three ways: its deposits were unusually sensitive to interest rates; its assets were unusually insensitive; and its client base was unique… The risk of contagion within the banking system appears to be limited. But at the end of every central bank rate-increase cycle, there comes a phase where things in the financial system begin to break. These breakages, minor or major, erode the confidence of investors and consumers, increasing the odds of recessions. The failure of SVB does not herald another 2008, but it does mark the beginning of the breakage phase.” —Robert Armstrong, Financial Times, March 10​

Blame deregulation?

Also, the biggest banks are more tightly regulated. A roll-back of Dodd-Frank exempted SVB from some of the stress testing larger banks are still subject to because it wasn't a giant:

“Some banking experts on Friday pointed out that a bank as large as Silicon Valley Bank might have managed its interest rate risks better had parts of the Dodd-Frank financial-regulatory package, put in place after the 2008 crisis, not been rolled back under President Trump. In 2018, Mr. Trump signed a bill that lessened regulatory scrutiny for many regional banks. Silicon Valley Bank’s chief executive, Greg Becker, was a strong supporter of the change, which reduced how frequently banks with assets between $100 billion and $250 billion had to submit to stress tests by the Fed.” —New York Times, March 10​

Cool cool cool.

Forecast

Will another of the 50 largest commercial banks in the US will fail in 2023? (Other than SVB.)

​​~10% chance​ ​​​​​

​​​​~30% chance​ ​​​​​

​​​​~50% chance​ ​​​​

​​​​​~70% chance​ ​​​​​

​​​​~90% chance​​​​​

The fine print

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Deadline: Make a forecast by 9am ET Tues. March 14.

Resolution criteria: For the purposes of this question, the 50 largest commercial banks in the US are the top 50 as listed by the Federal Reserve as of 31 December 2022 (Federal Reserve - Large Commercial Banks). The question will be suspended on 31 December 2023 and the outcome determined using data available from the Federal Reserve and open-source reporting. For the purposes of this question, a bank will be deemed to have failed if it files for bankruptcy, is taken over by the FDIC, or similar outcomes. The acquisition of a distressed bank by other institutions alone would not count (e.g., Federal Reserve - Wachovia).

The 50 largest commercial banks, as of Dec., are listed here. Below are the top 20:

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