by Guest Contributor Adam Russell
(Opinions expressed in this article are the author’s own)

These are all banks that appeared to be doing quite nicely last Monday but one week later, two are gone and the third is liquidating its assets to repay all depositors. What on earth happened?

Yes, this issue will be all about these three banks, given the excitement they generated in the banking world this weekend. If this bores you, swipe left, and we’ll talk next week.

Let’s start with what a bank does, very simply. It takes in deposits and takes that money and lends it out to individuals and businesses. It pays interest for the deposits, say 3%, and charges interest for its loans, say 7%. It also charges fees for most of its services. What it doesn’t lend out, it keeps a small amount in cash and invests the rest in various government securities so it can at least make a little money on what it hasn’t lent out.

  • That’s how it makes money; it keeps the net interest margin (the difference between the interest it pays and the interest it receives) and generates fee income.

  • It must lend prudently and under the watchful eyes of regulators since it is the FDIC that guarantees the deposits that they are lending out, up to $250,000 – remember that number.

  • In 2008, it was a credit problem that took down over 500 banks and the financial system due to badly approved residential lending, among other things. Not this time.

    • The credit is fine; the deposits were the problem. Wait, what??!! How can deposits put a bank out of business?

      • Well, when everyone wants their money right now. It doesn’t even need to be a lot of people; just a few big customers.

        • That’s what is called “A run on the bank”. This goes back to the early 1900’s. When word got out that a bank may or could fail, all the depositors would run to the bank to get their money out. Last one there was a rotten egg since the cash was gone by that time.

        • There was no FDIC government insurance to rely on at that time.

      • And this “Run” can happen because of concentrations in the customer base.

  • Like any business, a concentration of customers is a risk.

  • What is the problem, you ask? It’s all insured to $250,000; why the rush to pull out the money?

  • That’s true, but when the account has millions of dollars, any sign, legitimate or not, that the bank is NOT safe, leads to a crisis of confidence.

  • That’s what happened to Silvergate, a bank with roughly $10 billion in customer deposits.

    • Silvergate had a concentration of deposit accounts from companies that were part of the crypto industry. As the balances of those accounts began to decrease, Silvergate did not have enough cash on hand to pay off the depositors. So, it had to liquidate investments to generate cash. In this case, its long term securities portfolio – US treasuries and mortgage securities, triggering a loss from the sale.

      • That’s a bad thing, particularly in banking.

      • As soon as people hear the word Bank and Loss in the same sentence, it’s like chum to sharks. Everyone goes after their uninsured funds.

      • If you are the bank, it seems like everything, everywhere, all at once.

        • Except it’s not a movie.

        • For the CEO, it’s more like a terrible, horrible, no good, very bad day.

        • More so for the employees – I’ve been there and done that in 2008.

    • Unable to keep up with the orderly withdrawal of deposits, Silvergate made the decision to liquidate the bank, returning all deposits to its customers, averting any losses to its deposit base.

      • The regulators DID NOT take over Silvergate.

  • That was Wednesday. Then came Thursday.

  • The same crisis of confidence started spreading to two other banks.

  • First, it was Silicon Valley Bank, a $200 billion bank. Instead of crypto, its niche was tech start-ups.

    • When these start-ups are new, they bring millions, if not tens of millions, to the bank. Awesome, when times are good.

    • However, those deposits started to go down. So what, you say, just take the money out of the vault and give it to them. Well, *ahem* about that. The bank had invested that money in long term securities BEFORE interest rates went up.

        • I mean, the bank is just not going to keep billions in cash lying around just in case someone wants to withdraw it.

        • As mentioned, the bank will invest it in government securities so at least it can make some money out of it.

        • And so they did.

      • Well, when interest rates go up, the value of the securities, when liquidated early, go down. In this case, by a lot.

        • And the Fed has been raising rates by a lot.

      • Regardless, they sell the securities and just like Silvergate, they report a loss on the sale of $1.8 billion. With a B.

        • And there are those two words again: Bank and Loss.

        • When you have $40,000,000 in a bank that has posted a loss on the sale of securities to keep up with withdrawal demands, I don’t care how many times your account officer gave you courtside tickets; that money is coming out.

          • Assuming you have a different account at a different bank to send it to.

          • And you can do it on your phone in about 90 seconds.

        • By some accounts, over $150 billion of its total deposits were over the FDIC insurance amount of $250,000. That’s a concentration.

        • And $40,000,000,000 (count the zeros) tried to leave the bank on Thursday.

    • Silicon Valley Bank didn’t even conduct business on Friday.

  • And after the Silver and Silicon, all you need is a Signature.

  • Signature Bank was, by all accounts, a solid commercial business and real estate bank.

    • Except for an oh, so very slight association with crypto. Just like Silvergate.

    • It didn’t start that way, but it gained steam around 2019.

      • Let me be clear: they did NOT invest in cryptocurrency. They just opened accounts for firms that did. Very large accounts.

    • Cryptocurrency peaked in November 2021 and then started to lose steam and the deposits started to leave the bank.

    • After Wednesday at Silvergate and Thursday at Silicon, it was a miracle that Signature made it through Friday. It was so bad, this $100 billion bank was looking for a buyer over the weekend.

      • Employees learned yesterday afternoon that their company had been taken over by the FDIC and they had become employees of the Federal Government.

    • And that was that.

Epilogue: The US Treasury has put in a backstop to help banks secure liquidity without selling their government securities and posting a loss. That will help significantly. The Fed has also stated that ALL deposits at Silicon and Signature will be available; they are NOT lost. This is all very significant and will calm financial markets today. I can also promise you that there will be another layer of examination by the regulators at every bank to find out in more detail what their deposit risks are.

These banks thought they could build a niche business, and they did. You can specialize in something, but you can’t make it a significant part of what you do. This applies to any business; that niche goes away, you go away.

This article was originally published in The Russell Report by Adam Russell.