Bank Failures: How Bank Management Got Here and What We’ve Learned

For most people — from casual observers to financial market news junkies — the recent demise of a duo of regional U.S. banks has been a shock. “How could this have happened?” concerned citizens have wondered aloud. For those of us in the industry, though, on some level, it should have been predictable. The concept of what went wrong has had everything to do with time and acceleration, rather than simply the higher interest rates that some commentators would like to blame. 

Consider this analogy: if you’re riding in a car and the driver goes from zero to 60 miles per hour in a few seconds, you think, Wow, that was fast! In truth, Earth is spinning at 1,000 miles per hour and revolving around the sun at 67,000 miles per hour, and we never even feel it. However, if that constant forward motion were to stop or speed up suddenly, our planet’s residents would all feel jolted in a big way. 

The same concept is true for the banking industry and the recent collapse of two regional banks. Interest rates were hovering around zero for an extended period of time, and consumers were used to those low, or almost nil rates, of cheap money. Rather than a gradual climb, rates went from zero to an average of 4.65% from February 2022 to March 2023 — giving the industry the same effect as slamming on brakes in a fast-moving vehicle. 

Time was also a major contributing factor to what precipitated the gathering of deposits at some financial institutions. The pandemic closed off economic activity from a breakneck pace to practically nothing overnight. Those closures and the resulting inflation meant that the Federal Reserve has been steadily raising interest rates to try to stem the inflation tide. Historically, interest rates are neither “too high” nor “too low” as long as the market has time to adapt. 

Silicon Valley Bank was one of the fastest-growing banks in the country and had been in business for nearly 30 years. The bank was known for funding companies with new ideas and technologies most of us now use on a daily basis. They were the go-to bank for venture capital, private equity and much of the biotech in the United States, with 40-60% market share of those banking deposits. 

In a “cheap money” environment where interest rates are near zero, corporations and individuals find it easy to justify virtually any project, as the required rate of return is anything greater than zero. When interest rates go up to 5%, to justify the next project, you need to be confident of a 7-9% return. As a result, players in venture capital and private equity became more cautious, virtually overnight. 

What happens if you're lending in a low-interest environment and interest rates suddenly increase? In this case, duration mismatch because the banks had long-term assets, such as mortgages at low interest rates, paired with short-term liabilities in the form of deposits that could be withdrawn at will. This volatile environment was one of the key factors that led to the demise of Silicon Valley, in effect slamming on the brakes while their vehicle was barreling forward at a fast clip. 

Understanding the reasons this happened and learning from them is vital for making wise choices in the future. For most consumers — particularly ones who didn’t have funds with the failed entities — the top question on their mind is, “Could this happen again anytime soon?” The truth is, possibly, as certain regional banks will need to be recapitalized and, in addition, will require time to repair their balance sheets and customer confidence. 

While no one can fully predict the future, most of the United States’ banking system is less concentrated than Silicon Valley Bank. While SVB had mostly clients in biotech and venture capital, other major players such as JPMorgan Chase, Citibank and Bank of America have diversified client bases, with most depositors staying below the FDIC limits, making a run far less likely. By stepping in to cover the failed bank’s deposits, the government stemmed the tide of falling consumer confidence. 

It’s also important to note that having a diverse banking system, with both the large national banks and the smaller regional ones, is important for the health of the industry at large. Having more banks of varying sizes helps avoid a similar climate of the “too-big-to-fail” behemoths of the 2008 market crash. 

It remains to be seen what governmental regulations will be implemented to allow smaller banks to compete with larger ones. Regardless, understanding the road and having a strong understanding of the best path can give travelers peace of mind along the way.