In 2023, the banking industry faced significant challenges with three of the largest bank failures in American history. Silicon Valley Bank, Signature Bank, and First Republic Bank collapsed due to a decrease in the value of their asset portfolios as a result of the Federal Reserve raising interest rates and tightening monetary policy. This led to uninsured deposits leaving the banks in search of safer and more profitable options. There were concerns that this could cause a contagion effect in the rest of the banking industry, but so far, that hasn’t happened.
To address the liquidity and asset quality crises at these banks, the Federal Reserve intervened by providing support. They encouraged the use of the Discount Window for short-term loans and created the Bank Term Funding Program (BTFP) for longer-term loans with more flexible collateral requirements. The Fed also provided credit to the FDIC as they took over the failed institutions.
To prevent further deposit outflows, the Fed and FDIC made an unprecedented announcement that all depositors, including uninsured depositors, would be reimbursed. This move aimed to restore confidence in the banking system.
Initially, the troubled banks heavily relied on the Discount Window for loans, but as the crisis progressed, they switched to the more cost-effective BTFP. Over time, the FDIC loans decreased, and the total problem bank loans at the Fed peaked at $342 billion before gradually declining to $124 billion.
At first glance, the 64% drop in problem bank loans suggests an improvement in the banking industry. This is further supported by the performance of bank stocks, which have rebounded from their lows. The Fed has consistently stated that the U.S. banking system is sound and resilient in their releases following FOMC meetings.
However, a closer look reveals a different picture. Commercial banks have been accessing loans from the Federal Home Loan Bank (FHLB) in addition to the Fed’s lending facilities. The FHLB, originally established to provide liquidity to S&Ls, expanded its mandate to include commercial banks. During the banking crisis, many commercial banks turned to FHLB advances as a source of liquidity instead of the Fed. This was because FHLB advances were cheaper and operationally easier to obtain.
The failure of Silicon Valley Bank was primarily due to losses in their holdings of US Treasury bonds. The banking industry has also faced deterioration in their loan portfolios, particularly in commercial real estate (CRE). Smaller regional banks have a higher exposure to CRE compared to larger banks.
The CRE market has been impacted by the post-pandemic work environment, with an increase in remote work leading to a decrease in the demand for office space. This has resulted in higher vacancy rates nationally.
Overall, while there have been improvements in some aspects of the banking industry, there are underlying challenges and vulnerabilities that need to be addressed.
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