How many banks are at risk?

With amazing speed and impeccable timing, Erika Jiang, Gregor Matvos, Tomas Piskorski and Amit Seru analyze the extent to which the rest of the banking system is exposed to higher interest rates.

Summary: SBV failed largely because it funded a portfolio of long-term bonds and loans with run-on uninsured deposits. Interest rates rose, the market value of assets fell below the value of deposits. When people wanted their money back, the bank had to sell at low prices, and there wouldn’t be enough for everyone. Depositors ran first to get their money. In my previous post, I expressed surprise that the huge apparatus of banking regulation did not notice this huge and elementary risk. You need to add 2 + 2: a lot of uninsured deposits, a large interest rate risk. But 2+2=4 is not higher mathematics.

How common is this problem? And how widespread is regulatory violation? One would think that when you put on a parachute before jumping out of a plane, the Fed was checking that raising interest rates to fight inflation would not empty many banks.

Banks are allowed to report “hold to maturity”, “book value” or nominal value of long-term assets. If the bank bought the bond for $100 (book value) or if the bond promises $100 in 10 years (hold to maturity), basically the bank can say it’s worth $100 even if the bank can only sell the bond. for $75 if they need to stop the run. So one way to ask the question is how much lower is the market value compared to the book value?

Article (abstract):

The market value of the assets of the US banking system is $2 trillion lower than their book value suggests, taking into account held-to-maturity loan portfolios. Bank assets valued at market value declined by an average of 10% across all banks, with a 20% decline in the bottom 5th percentile.

… 10 percent of banks have larger unrecognized losses than SVB. SVB was also not the worst-capped bank, with 10 percent of banks undercapitalized than SVB. On the other hand, SVB had a disproportionate share of uninsured funding, with only 1 percent of banks having higher uninsured leverage.

… Even if only half of uninsured depositors choose to withdraw funds, nearly 190 banks are exposed to potential impairment risk for insured depositors, with insured deposits potentially worth $300 billion. … these calculations show that the recent decline in the value of banking assets has greatly increased the vulnerability of the US banking system to the flight of uninsured depositors.

Date of:

we use bank call report data that reflects the composition of assets and liabilities of all US banks (over 4,800 institutions) combined with market prices for long-term assets.

How large and widespread are unrecognized losses?

Banks’ unrealized losses average around 10% after market revaluation. The top 5% of banks with the largest unrealized losses see asset declines of around 20%. Note that these losses represent a staggering 96% of the bank’s total capitalization before tightening.

Percentage of asset value reduction when revaluing assets at the market price in accordance with the increase in the market price from Q1 2022 to Q1 2023

Most banks operate (in my opinion) with tiny bits of capital – 10% or less. So a 10% decrease in asset value is a lot! (Banks get money by issuing shares and borrowing money. Capitalization ratio is how much money banks get by issuing shares/assets. Capital is No reserves, liquid assets “held” to satisfy savers.) In the right panel, the problem No limited to small banks and small amounts of dollars.

But… it’s all a bit old data. How much worse would it get if the Fed raised interest rates by a few more percentage points? A lot of

Raid requires 2+2 to get 4. How widespread is dependency on uninsured raidable deposits? (Or deposits that were subject to forfeiture until the ex-post Fed and Treasury guaranteed all deposits!) SVB was an exception here.

The average bank finances 9% of its assets with equity, 65% with insured deposits and 26% with uninsured debt, including uninsured deposits and other debt financing… uninsured debt to assets ratio… SVB was in 1st percentile of the distribution of insured leverage. More than 78 percent of its assets were funded by uninsured deposits.

But it’s not quite alone

95th percentile [most dangerous] the bank uses 52 percent of the uninsured debt. For this bank, even if only half of the uninsured depositors panic, it results in one-fourth of the total amount pegged to the market value of the bank being withdrawn.

The ratio of uninsured deposits to assets, calculated on the basis of balance sheets for 1 quarter. 2022 and market value

In general, however,

… we consider whether the assets in the US banking system are large enough to cover all uninsured deposits. Intuitively, this situation would arise if all uninsured deposits were released and the FDIC did not close the bank before the end of this period. …virtually all banks (with the exception of two) have sufficient assets to cover their liabilities on uninsured deposits. … uninsured savers have little reason to run.

… SVB, there is [was] one of the worst banks in this regard. His market assets even [were] barely enough to cover their uninsured deposits.

Breathe a sigh of relief.

What strikes me in the tables is the lack of wholesale funding. Banks used to get a lot of money from buyback agreements, commercial paper, and other uninsured and depleting sources of funding. If it’s over, so much the better. But I may misunderstand the tables.

Summary: Banks borrowed short and long without hedging their interest rate risk. As interest rates rise, the value of bank assets will fall. It has all kinds of offshoots. But for now, there is no danger of a mass exodus. And a full guarantee on all deposits excludes this in any case.

Their result:

There are several medium-term regulatory measures that could be considered in the event of an uninsured deposit crisis. One is to expand even more complex banking regulation on how banks account for market losses. However, such rules and regulations, applied by multiple regulators with overlapping jurisdictions, may not always solve the underlying problem.

I love restrained prose.

We need a retrospective. Like 100,000 pages of rules not enough to determine the usual duration risk – there are no complex derivatives here – in combination with uninsured deposits? If four writers can do it in a weekend, how can the entire Fed and state regulators miss it in a year? (OK, four really smart and hardworking authors, but still…)

Alternatively, banks may face stricter capital requirements… Discussions of this nature remind us of the heated debate that took place after the 2007 financial crisis, which many felt did not lead to enough progress on banks’ capital requirements. ..

My bottom line (again)

This fiasco proves that the whole architecture is hopeless: guarantors and other lenders, regulators will make sure that banks do not take on too many risks. If they don’t see it, they won’t be able to patch up the ship again.

If banks put all deposits into interest-bearing reserves or short-term treasury debt and finance all long-term loans with long-term liabilities, long-term maturing debt, and large amounts of equity, we would end financial crises in the private sector forever. Are the benefits of the current system worth it? (Connecting to “to the financial system without a run.“Private sector” because sovereign a debt crisis is something else entirely.)

(Several other points stand out in the SBV fiasco. Apparently SBV did try to issue shares, but the FDIC intervened before they could. Apparently the Fed was trying to find a buyer, but the administration’s anti-merger sentiment plus bad memories of how the buyers after 2008 stopped it.