Are banks – and your money – safe? Five questions.

The Explainer

The failure of two U.S. banks within the past week does not constitute a banking crisis. Instead, it’s a worrying spark of fear that has been spreading. Consumers wonder whether their money is safe.

Some small businesses, especially tech startups, are scrambling to find new banks that can meet their needs such as making payroll.

How far the problem spreads will depend on the trajectory of the economy as well as on consumers’ confidence in their banks. For clues, watch the stock market, analysts say. If bank stocks fall further, that could signal trouble ahead for the economy. 

What happened?

Last Wednesday, Silicon Valley Bank, based in Santa Clara, California, announced it had sold some of its assets at a loss and would sell new shares of itself to boost reserves. That triggered SVB customers to begin pulling out their money, causing a run on the bank. By Friday, regulators had taken over the bank.

The collapse of SVB panicked depositors of New York-based Signature Bank, who began withdrawing their money Friday. By Sunday, regulators had taken it over as well. These were the second- and third-largest bank failures in U.S. history, topped only by the 2008 collapse of Washington Mutual in the financial crisis. Both banks were unusual in that they had concentrations of customers in struggling industries: tech startups in the case of SVB; and holders of digital money, known as cryptocurrencies, in the case of Signature.

How close are we to a banking crisis?

It depends on what lens you’re looking through: history or today’s banking structure. One of the lessons of history is that nations don’t need to see a full-blown panic – such as runs on numerous banks à la 1930s – to experience a banking crisis. A 2020 study of banking debacles in 46 countries going back to 1870 found that a 30% average decline in the stock prices of a nation’s major banks typically led to a recession three years later and a sizable decline in overall lending. Through Monday, the S&P Banks Select Industry Index had fallen nearly 23% this month. William Isaac, former head of the Federal Deposit Insurance Corp. (FDIC), told Politico he expects more banks to fail.

The flip side of that dire outlook is that the banks that might fail this time are likely too small to bring down the banking system. The biggest U.S. banks – those considered “too big to fail” – look far stronger financially than they did in 2008, when the financial crisis forced the federal government to bail out many of them. This time, while aiding depositors, regulators did not bail out SVB or Signature, and the Securities and Exchange Commission and the Justice Department reportedly are investigating SVB. 

What should you do?

If you’re an average bank customer, relax. At any FDIC-insured institution (nearly all banks) your deposits are guaranteed for up to $250,000 (that’s $500,000 for joint accounts). Those totals apply whether money is in savings, checking, or certificates of deposit. If you have more than that at any one bank, spread it around to other insured financial institutions. If you’re a small-business owner, who does keep more than $250,000 at a single bank, diversify.

For investors, the outlook is more uncertain. Investment risk has gone up as a result of the two bank failures, but whether it has peaked is unknown. 

Should regulators have foreseen the problems?

Hindsight is, of course, 20/20. Still, many observers say regulators missed the boat, especially with SVB. They should have seen that the bank’s assets were too concentrated in U.S. government bonds. While those bonds were rock solid in an accounting sense, they were losing value in the marketplace because they were bought before the Federal Reserve began raising interest rates. The value of old bonds always goes down when interest rates rise because investors prefer buying new bonds that earn a higher rate. As onetime chief economist of the Office of the Comptroller of the Currency, Charles Calomiris says he urged regulators to consider the market value of a bank’s assets, not just the accounting value. But “it’s so contrary to their culture that they just don’t do it,” he says.

What happens now?

Time will tell whether regulators have calmed depositors to the point that there will be no more bank runs in the coming months. Instead of bailing out the banks, regulators rescued their depositors. That itself was a controversial move, but one that many economists saw as necessary under the circumstances to stem a potential spread of fear about the safety of banks. Big depositors at both banks were relieved.

“Folks would have certainly appreciated maybe a little bit earlier reassurances” from the government, says Ruben Izmailyan, co-founder and CEO of Quiltt Inc., a Dallas-based fintech firm that had big deposits at SVB. But had regulators and the Biden administration not acted, hundreds of tech startups might have been at risk.

Some financial experts worry about the precedent set by bailing out all depositors at a bank, rather than just those with $250,000 or less in their accounts. Regulators will be hard-pressed to deny equal protection to big depositors the next time a bank fails, even though it could be very expensive for the FDIC. 

And Mr. Calomiris, now a Columbia Business School professor, is critical of the Biden administration’s new lending program for other banks potentially facing runs by depositors. “It can’t possibly work,” he says, if regulators base those loans on the par value, rather than on the market value, of government bonds that the banks hold. The plan calls for institutions to repay those loans in a year, when, if anything, the bonds will likely be worth even less.

The Fed has its own conundrum when its rate-setting committee meets next week. Should it raise interest rates and continue its aggressive fight against inflation? Or is it wiser to pause, given the jittery state of investors? Year-over-year inflation rose at a slower rate last month than at any time since September 2021. But at 6%, it remains stubbornly high.