It can be very unsettling to hear of a bank failure such as Silicon Valley Bank (SVB) last month. Investors may wonder how they should react or if they should adjust their portfolios. First, a little …
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It can be very unsettling to hear of a bank failure such as Silicon Valley Bank (SVB) last month. Investors may wonder how they should react or if they should adjust their portfolios.
First, a little history lesson to put this into perspective.
When depositors rush to get their money out of a bank that is financially in trouble, it is called a “run” on the bank. These are not new and have occurred at different levels of severity in the past, the worst in the 1930s during the Great Depression. At that time, there was contagion across many banks, not our current situation. While bank insolvency can often come on the heels of the Federal Reserve Board raising interest rates, that is not solely the cause, according to Mariner Wealth Advisors Chief Economist William Greiner.
Each bank must manage the risk of lending, investing, cash deposits and withdrawals. If any or all of those are out of balance, problems start to percolate. When you have high-risk loans, such as technology start-ups, and you are short on liquidity (more withdrawals than deposits), and the investments backing the deposits decline in value, you have a recipe for failure.
Many banks issue loans on real estate or other business collateral. They may also use Treasuries to back up deposits. When the Fed raises interest rates, and the value of those Treasury bonds declines, bankers may need to sell at a loss to cover withdrawals. Once this spiral starts, or collateral is devalued due to bad loans, depositors may demand their money causing a run on the bank.
Fed Chairman Jerome Powell remained concerned about inflation when he testified before Congress in March. This drove interest rate expectations higher after several interest rate hikes over the last three quarters. This downward pressure on bond values and concerns the bank would need to raise capital, caused some technology-focused venture capital companies to remove funds from SVB.
It was very fortunate that a contagion was avoided, as the U.S. government response was swift and effective. Once the facts were released and average depositors realized they were not involved in a bank that does high-risk lending, some of the pressures eased.
Investors will likely review their portfolio to make sure they are not invested in small banks in the venture capital space or have heavy exposure to commercial real estate. They may also avoid banks that have not had proper risk management or oversight. These things created a perfect storm scenario for SVB. It may be wise to stay with large institutions commonly known as “too big to fail” due to their backing by the Fed. Large banks may actually benefit from depositors moving money to them from small banks in amounts not covered by the $250,000 limit for FDIC insurance.
Jimmy Stewart as George Bailey in “It’s a Wonderful Life” was able to instill trust in his customers to survive a run on his bank during the Great Depression. In real life during that time, the Emergency Banking Act of 1933 formed the Federal Deposit Insurance known as FDIC.
These days you don’t really run to your bank and can click to manage transactions on your phone. It is not recommended to keep large deposits in any one institution, just as you would not put all of your investments in one individual stock. Work with your wealth advisor to determine the right amount to leave in the bank, which is usually designed for transactions or emergency reserves, not large sums that could be working harder for you elsewhere.
Patricia Kummer has been a Certified Financial Planner professional and a fiduciary for over 35 years and is managing director for Mariner Wealth Advisors.
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