There have been numerous bank failures recently. In fact, some of the largest in US history. It seems like it wasn't too long ago that we had widespread bank failures. So how is it, with all that we've learned, that banks are on the brink of collapse once again?
Before we begin discussing the current situation, we need to back up to the Great Recession in 2008 so that we can understand what lead up to where we are today. During the Great Recession, there was a cascade of bank failures due to risky lending and highly leveraged institutions. One failed bank lead to the failure of another bank and so on. Banks were so poorly capitalized that there was massive systemic risk. It didn't take much for one failed bank to cause the collapse of another due to obligations owed.
Following the aftermath of the Great Recession, an international banking committee came up with the Basel III accords which describe a set of standards for banking. The US announced that it would plan to implement these standards. One goal of these new regulations was to ensure banks were better capitalized so that they could better absorb economic shock without leading to complete collapse.
Through the FDIC, new capital rules were announced and implemented that would ensure banks would have a proper ratio of capital based on the risk of the assets held by that bank. With these regulations, the FDIC's risk-weighting placed US Treasury bonds at the lowest risk tier. These new risk-based capital requirements helped push banks into the direction of owning "risk-free" US Treasury bonds.
It is important to understand the relationship between bonds, interest rates, and the bond market. Treasury bonds are US debt. Purchasing a Treasury bond is a loan to the government that pays out a yield at the end of the maturity date. This yield is set by the current interest rate. The downside is that your money is locked in for the entire term. However, you can sell this bond on the bond market to any potential buyer should you need access to the capital being held by the bond. The price you'll get for that bond on the market, however, is determined by the interest rate you acquired when purchasing that bond in relation to the current interest rate set by the Fed. If you purchased a bond with an interest rate of 4%, but now the current interest rates for new bonds are only 3%, you could demand a higher premium for your bond since it pays a better yield than if you were to get a newly issued one. This also works in reverse. If you purchased a bond at 3% and now interest rates have risen to 5%, you're going to have to sell your bond on the market for less than what you paid for it since someone could just go buy a new bond and get a much better rate.
Understanding this relationship between bonds and interest rates is important and now takes us to the start of the pandemic. With the economy stressed due to uncertainty, lockdowns, and supply chain issues, the government infused the economy with massive amounts of cash. Pretty much everyone was getting cash in some form, whether you were an individual or a business. If you were a bank, times were great. Deposits sky-rocketed, but due to economic anxiety, people weren't borrowing and supply chain issues and fears over additional covid variants prevented businesses from doing the same. So banks were sitting on piles of cash and being in the business of money requires them to earn something on that money. So they turned to US Treasuries even though rates on these bonds were near historic lows. Any yield was better than no yield and Treasuries were seen as very low risk.
From the implementation of the new Basel III regulations in 2015 to this point in time, banks had increased their exposure to US Treasuries to all-time highs. From 2015 to 2022, Treasury holdings by commercial banks more than doubled, going from about $2T to over almost $4.7T. While the Basel III capital requirements classified US Treasuries in the lowest risk tier of assets, these Treasuries are very much exposed to interest rate risk set by the central bank.
With the massive influx of money into the economy due to the pandemic, the economy was now faced with some of the worst inflation in nearly half a century. In response to this, the Fed increased interest rates at the fastest pace since the early 1980's. This increase in interest rates really put pressure on all the banks that were now some of the largest holders of public debt.
One of these banks really feeling the pain of these interest rate increases was Silicon Valley Bank (SVB). They held large amounts of capital in US Treasuries that were purchased as historically low rates. SVB's clientele is mostly wealthy tech and venture firms with large amounts of capital. About 97% of its customer base had funds at SVB in excess of the FDICs insurance limit. So when word got out to its customers that SVB was being forced to sell some of its bonds on the market for substantial losses, a bank run ensued.
The government, after printing trillions of dollars into the economy causing massive amounts of inflation, took corrective action to attempt to curb this inflation by raising interest rates. All the while it was blind to the risks in doing so to the banks that it regulated into holding "risk-free" US Treasuries. The reality is that nothing is risk-free. When you deposit funds into a third-party financial institution, there is real liability there that is beholden to risks that come with the capital allocation of that institution. Banks are no longer required to hold a reserve of deposits in any ratio equal to the amount of total deposits it has. This means that your deposited money is directly funding additional financial activity that the financial institution pursues. While the intentions of the Basel III accord might have been good, in hindsight it did little to stem this liability risk that deposits are exposed to when getting into a relationship with a third-party financial institution. All it did was shift where that risk lies. In this case, it shifted that risk toward the whims of a central bank that has failed to exhibit the ability to responsibly manage the money supply.
It is no wonder that an increasing number of people all over the world are seeing the merits of bitcoin that isn't exposed to the volatility of central banking monetary policy. Bitcoin's monetary policy is strictly enforced through the code run by thousands of decentralized nodes all around the world. Bank failures are inevitable and there is a growing trend that is the consolidation of financial institutions into larger and fewer banks as more and more banks collapse. The imperative to own bitcoin only becomes more clear.
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