SVB Clients Get a Painful Lesson: Bank Failures Are Common

A customer reads a press release at the entrance of the Silicon Valley Bank headquarters in Santa Clara, California, US, on Friday, March 10, 2023. Silicon Valley Bank became the biggest US bank failure in more than a decade, after its long-established customer base of tech startups grew worried and yanked deposits. (Photographer: Bloomberg/Bloomberg)

Bank failures are surprisingly common: There have been 565 of them in the US since the turn of the millennium. Many occurred in the aftermath of the global financial crisis, but even in more benign periods, banks have gone bust. Between 2011 and 2020, banks collapsed at a rate of around two a month.

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What makes Silicon Valley and Signature Bank special is not only their size — they are the second- and third-largest bank failures in US history — but also how much time elapsed since a bank before them failed. Prior to Silicon Valley Bank entering receivership on Friday, the last bank to fail was Almena State Bank, of Almena, Kansas, in October 2020. The 868-day lull between the two failures was the second-longest stretch on record, the longest being in the run-up to the financial crisis.

Such a long time without news of a bank collapse may have lulled depositors into a false sense of security. Without a reminder that banks can and do fail, depositors got caught up in a euphoria that touched a host of asset classes during the period, from tech stocks to digital currencies to long-dated bonds. Bank customers channeled billions of dollars into uninsured deposits.

Since 2008, US depositors have enjoyed a guarantee on their first $250,000 of deposits. The cap was raised from $100,000 during the financial crisis, initially as a temporary measure before being made permanent two years later. At the time, it was hugely valuable. But as memories dimmed, it began to lose its luster. When the cap was raised, it covered 98% of depositors and 80% of domestic deposits; by 2022, only 55% of domestic deposits were covered by insurance. In the past three years alone, uninsured deposits have grown by over $2.2 trillion.

Some uninsured deposits flowed into sound banks. Time deposits at JPMorgan Chase & Co. in excess of the insurance cap doubled over the past two years. But several smaller, fast-growing banks attracted a fresh vintage of depositors, unencumbered by memories of counterparty risk. Offering superior customer service, Silicon Valley Bank persuaded its customers to give up the benefits of insurance and tripled its deposit base over three years; by the end of 2022, 80% of its domestic deposits were uninsured. Signature Bank similarly took its mix of uninsured deposits up to 89%.

For now, policymakers have removed the risk of a run on uninsured deposits after announcing that all depositors of these two failed banks would be protected. But not before a weekend of anguish. In past resolutions, uninsured depositors got back around 90% of their deposits. In the case of Silicon Valley, the recovery would likely have been higher given the nature of its assets — principally, government securities and performing loans — but customers didn’t know how long they’d have to wait.

Going forward, the framework that covers deposit insurance may have to change. Having been introduced to protect depositors from the actions of banks, its role may increasingly be to protect banks from the actions of depositors.

The speed of the deposit exodus at Silicon Valley Bank is unprecedented. In 2008, Washington Mutual lost $17 billion of deposits over two weeks before being shut down by regulators as the largest bank failure in US history. Silicon Valley Bank lost 2.5 times that in a single day.

The stability of a bank’s funding base comes from the uncorrelated behavior of its depositors. Drive up coordination via WhatsApp groups, social media messaging and the like, and deposit bases can become less resilient. Silicon Valley Bank is an extreme case of this, as its depositor list was heavily concentrated, but for all except the very largest banks it’s a real risk.

In addition, electronic banking makes it possible for deposit withdrawals to be executed quickly. In the past, the natural friction of waiting in line gave banks time to address funding challenges. Today, electronic wires still keep business hours, giving banks some breathing room, but the introduction of FedNow, a new instant payment platform scheduled to launch later this year, will change that. The platform will allow customers to transfer up to $500,000 any time day or night, twice the current threshold for insured deposits.

As banking changes, the frameworks that underpin it must change too. Premiums to support insurance schemes are paid for by the industry and therefore ultimately by end customers. Higher fees will remind them of the value in insurance.