US banks are well positioned for a serious disaster at the time of writing. A mix of rising interest rates, unrealized deficits, and uninsured depositors contributed to the chaotic situation. So, can cryptocurrencies like bitcoin help?
The demise of Silicon Valley Bank (SVB) marked the beginning of a crisis of confidence in the US banking sector. Americans, especially uninsured depositors, are scrambling to determine whether their deposits are at risk. According to a recent study, 186 banks, representing five percent of all US-based banks, face a high risk of succumbing to a similar fate.
What are some of the major risks involved should the crisis unfold, and what will be the effects around the world?
fragile banking situation
Some economists published a study titled ‘Monetary Tightening and US Bank Fragility in 2023: Mark to Market Losses and Uninsured Depositor Run’. Some of the key highlights were shared with BeInCrypto.
There is a risk of US banks going under, given the assets banks hold on their balance sheets, ie US bonds. They are also known as bundles of US government debt and mortgage-backed securities (MBS) mortgages. According to regulators, these bonds and MBS are the safest assets of the bank. Banks invest most of their customer deposits in US bonds and MBS. These assets earn interest for the banks and thus make it possible for the institutions to provide services for little or no fee.
However, when interest rates go up, the value of US bonds and MBS goes down. Specifically, higher interest rates result in US bonds and MBS crashing. If the value of these assets falls too much, banks may become temporarily insolvent. This bankruptcy is temporary because when US bonds and MBS mature, the bank receives the total value of the underlying assets at the end of the loan terms.
This temporary bankruptcy is because banks do not report losses on US bonds and MBS when interest rates rise. This is simply because it is a loss once sold, and in the case of US bonds and MBS, banks will only lose something if they hold them until maturity.
Why did Silicon Valley Bank collapse?
However, these so-called unrealized losses are allowable as long as the bank is not forced to sell any assets upon withdrawal of the customer. Unfortunately, the collapse of SVB proved otherwise. 92.50% of SVB’s deposits were not insured by the Federal Deposit Insurance Corporation, or FDIC. For context, the FDIC only insures bank deposits up to $250,000 per account; Any amount above this is considered uninsured. The bankrupt bank experienced a bank run as its uninsured depositors could see that it had many unrealized losses. This led to speculation that the SVB did not have sufficient funds to meet all withdrawals.
About $9 trillion in bank deposits are uninsured in the United States, which is roughly 50% of all bank deposits. Banks are happily investing uninsured deposits in US bonds and MBS. The problem is that interest rates have gone up, and their unrealized losses are piling up. In fact, at the end of 2022, US banks collectively had unrealized losses of over $600 billion. Interest rates have risen further since then, so these losses are likely to be even wider.
In the study, economists examined nearly four thousand banks to see which ones are most at risk and why. They found that 42% of all bank deposits are invested in regular MBS, with the other 24% invested in commercial MBS, such as commercial real estate loans, US bonds and other asset-backed securities (ABS).
Zooming in on the unrealized losses on these assets after crunching the numbers, the researchers said:
“The average value of unrealized losses of banks is around 9% by market value. The 5% of banks with the worst unrealized losses saw their assets decline by nearly 20%. We note that these losses account for an astonishing 96% of total bank capitalization pre-tightening.
What is at stake here?
Global systemically important banks or GSIBs such as JP Morgan and Bank of America have less than five percent of unrealized losses. The average non-GSIB has 10% unrealized losses, and SVB wasn’t even the worst. Surprisingly, more than 11% of US banks have significantly higher unrealized losses than SVB when it went down.
While the collapse of the SVB is a reminder of the fragility of the traditional financial system, many banks are at risk from uninsured deposit withdrawals, it read:
“Even if only half of uninsured depositors decide to withdraw, approximately 190 bank insured depositors are at potential risk of loss, with potentially $300 billion of insured deposits at risk.”
The researchers concluded that assets held by US banks are more than two trillion dollars less than reported, thanks to unrealistic loss-based accounting.
Furthermore, it was reiterated that hundreds of banks are at risk of collapse if uninsured depositors withdraw money. To make matters worse, the latest hike in interest rates added to the uncertainty.
Rising interest rates raise red flags
Rising interest rates can actually affect the asset market value of banks and put their stability at risk. When interest rates rise, the value of existing fixed-rate assets held by banks, such as mortgages, bonds and other loans, may decline as these assets become less attractive to investors who can find higher returns elsewhere. Are. Additionally, as interest rates rise, the cost of borrowing for banks increases, which can reduce their profitability and make it more difficult for them to generate sufficient returns to meet their obligations.
If the decline in asset values is significant enough, it can erode a bank’s capital, making it more vulnerable to potential losses or sudden increases in withdrawals by depositors. In the worst case, this could lead to stress on the bank, which could further destabilize the banking system.
The situation may worsen if a bank has a large proportion of uninsured deposits. When depositors’ funds are not insured by the Federal Deposit Insurance Corporation (FDIC), they are not protected in case of bank failure. This could lead to a situation where depositors rush to withdraw their funds at the first sign of trouble, which could further undermine bank stability and potentially trigger a wider financial system crisis.
Is The Grass Greener On The Crypto Side?
Andrew LokenothA writer with over 15 years of experience in finance spoke to BeInCrypto on the matter. Taking a different approach, he said:
“It is equally important to remember the cyclical nature of interest rate fluctuations (for a balanced perspective). If interest rates start to fall, losses can be reversed, so banks need to hold on to their bond holdings. These losses may not be experienced. It is important to note that these losses are only on paper, and the banks will not see any losses unless they sell their bond holdings.
At the same time, the federal government took steps to protect depositors of SVB and Signature Bank.
Nevertheless, the chaos of the banking system damages its credibility. On the other hand, given the brewing situation, cryptocurrencies come in handy. The primary issue with cryptocurrencies is the volatility of their prices. But the largest and most established cryptocurrencies, such as bitcoin, have been battle-tested for over a decade. Furthermore, cryptocurrencies are one of the best hedges against the banking system.
But again, rapid CBDC development could jeopardize the decentralization aspect, giving governments control over usage.
All information contained on our website is published in good faith and for general information purposes only. Any action the reader takes upon the information found on our website is strictly at their own risk.