The 2023 United States banking crisis was a series of bank failures and bankruptcies that took place in early 2023, with the United States federal government ultimately intervening in several ways. Over the course of five days in March 2023, three small-to-mid size U.S. banks failed, triggering a sharp decline in global bank stock prices and swift response by regulators to prevent potential global contagion. Silicon Valley Bank (SVB) failed when a bank run was triggered after it sold its Treasury bond portfolio at a large loss, causing depositor concerns about the bank's liquidity. The bonds had lost significant value as market interest rates rose after the bank had shifted its portfolio to longer-maturity bonds. The bank's clientele was primarily technology companies and wealthy individuals holding large deposits, but balances exceeding $250,000 were not insured by the Federal Deposit Insurance Corporation (FDIC). Silvergate Bank and Signature Bank, both with significant exposure to cryptocurrency, failed in the midst of turbulence in that market, especially following major losses during the bankruptcy of FTX.
In response to the bank failures, the three major U.S. federal bank regulators announced in a joint communiqué that extraordinary measures would be taken to ensure that all deposits at Silicon Valley Bank and Signature Bank would be honored. The Federal Reserve established a Bank Term Funding Program (BTFP) to offer loans of up to one year to eligible depository institutions pledging qualifying assets as collateral.
To prevent the situation from affecting more banks, global industry regulators, including the Federal Reserve, the Bank of Canada, Bank of England, Bank of Japan, European Central Bank, and Swiss National Bank intervened to provide extraordinary liquidity.
By March 16, large interbank flows of funds were occurring to shore up bank balance sheets and some analysts were talking of a possibly broader U.S. banking crisis. The Federal Reserve discount window liquidity facility had experienced approximately $150 billion in borrowing from various banks by March 16.
Soon after the bank run at SVB, depositors quickly began withdrawing cash from San Francisco-based First Republic Bank (FRB), which focused on private banking to wealthy clientele. Like SVB, FRB had substantial uninsured deposits exceeding $250,000; such deposits constituted 68% of the bank's total at year-end 2022, declining to 27% by the end of March, as $100 billion in uninsured deposits were withdrawn. Despite a $30 billion capital infusion from a group of major banks in March, FRB continued to destabilize and its stock price plummeted as the FDIC prepared to take it into receivership and find a buyer on April 29. On May 1, the FDIC announced that First Republic had been closed and sold to JPMorgan Chase.
Background
COVID-19 pandemic and federal stimulus In financial markets, primary dealers purchase government securities (such as U.S. Treasury Securities) directly from the U.S. Treasury during regular auctions to ensure the national debt is funded, while secondary dealers and commercial banks trade these existing assets on the secondary open market. By doing so, primary dealers secure a privileged gatekeeping position that allows them to serve as the sole counterparties for the Federal Reserve’s monetary policy operations and profit from the bid-ask spreads inherent in maintaining secondary market liquidity. Examples of primary dealers include JPMorgan Chase, Goldman Sachs, Wells Fargo, and Citigroup. Examples of secondary dealers include regional banks, specialized hedge funds, and at one point, Silicon Valley Bank (SVB).
During the early years of the COVID-19 pandemic between 2020 and 2021, as customers shifted to digital services, tech startups saw record fundraising levels. As a result, commercial banks serving tech clients such as SVB saw total deposits grow from $62 billion in March 2020 to $189 billion by the end of 2021.
At the same time, following massive stimulus into the U.S. economy by the federal government and the Federal Reserve at the start of the pandemic, corporate and consumer demand for traditional commercial loans decreased significantly as tech firms were flush with venture capital and pandemic stimulus-related liquidity, and therefore had little need for conventional debt. Consequently, banks were forced to find alternative vehicles for their idle cash to generate a profit (a core institutional function) leading them to park these massive reserves into the bond market. They favored long-dated U.S. Treasury Securities and mortgage-backed securities (MBS) because these offered slightly higher yields than short-term investments and were perceived as "risk-free" at the time.
Interest rate risk and bond market devaluation However, the yields on early pandemic U.S. Treasuries had been driven to near-zero levels as the Federal Reserve suppressed interest rates (via quantitative easing; rapidly repurchasing U.S. Treasuries from primary dealers on the secondary market and flooding those sellers with instant cash reserves) to stabilize the financial market following the 2020 pandemic lockdowns. The reason yields went down is because when the Fed creates an artificial surge in demand by aggressively bidding up the price of existing bonds, the fixed interest payments on those bonds represent a smaller and smaller percentage of the increased purchase price, thereby mathematically compressing the yield toward zero. For example, if one pays $1,000 for a bond that pays $20 a year, the yield is 2%. But, if the Fed starts a bidding war and drives the price of that same bond up to $2,000, that $20 payment now only represents a 1% yield. The payment didn't change; the entry price did. By overpaying for bonds, the Fed effectively forced the "interest rate" of the entire market to collapse.
Thereafter, these low rates incentivized aggressive speculation and record-breaking capital infusions into the tech sector throughout the pandemic, which significantly inflated bank deposit bases. However, the subsequent Federal Reserve interest rate hikes in 2022, enacted to combat the 2021-2023 inflation surge, caused bond prices to decline sharply. This is so because of a concept called bond convexity, where when interest rates rise from the fed funds rate, new bonds are issued with higher coupon payments (due to market forces against the U.S. Treasury to issue higher yields as a hedge against the fear of inflation), which makes existing bonds with lower rates appear unattractive. Therefore, to entice a reasonable investor to purchase these older, lower-yielding bonds, their market price must drop until their total return (consisting of the original low interest plus the discount on the purchase price) aligns with the newer, higher market rates.
This scenario is precisely what happened to SVB. Consequently, this collapse in market value eroded bank capital reserves and forced Silicon Valley Bank to sell its devalued assets in the secondary market to maintain liquidity, realizing the steep losses that ultimately triggered its collapse.
Venture capital and cryptocurrency volatility In addition, several banks gained market exposure to cryptocurrency and cryptocurrency-related firms prior to and during the COVID-19 pandemic; the 2020–2022 cryptocurrency bubble popped in late 2022. In this environment, three such banks failed or were shut down by regulators: The first bank to fail, cryptocurrency-focused Silvergate Bank, announced it would wind down on March 8, 2023, due to losses suffered in its loan portfolio. Two days later, upon announcement of an attempt to raise capital, a bank run occurred at Silicon Valley Bank, causing it to collapse and be seized by regulators that day. Signature Bank, a bank that frequently did business with cryptocurrency firms, was closed by regulators two days later on March 12, with regulators citing systemic risks. The collapses of First Republic Bank, Silicon Valley Bank and Signature Bank were the second-, third- and fourth-largest bank failures in the history of the United States, respectively, smaller only than the collapse of Washington Mutual during the 2008 financial crisis.
In 2019, the Federal Reserve's "Tailoring rules" changed, increasing minimum asset threshold from $50 billion to $100 billion and reduced the number of required stress testing scenarios, allowing banks with under $100 billion to have reduced liquidity standards. Signature Bank and First Republic Bank were under the $100 billion total assets for the Federal Reserve's tailoring rules, allowing the banks to have reduced regulation for liquidity. Some have questioned if First Republic Bank would have had a bank run if there were similar regulation to EU countries in the United States.
Liquidation of Silvergate Bank
Background Silvergate Bank was a California-based bank that began operations in 1988 as a savings and loan association. In the 2010s, the bank began to provide banking services to players within the cryptocurrency market. The bank sought regulatory approval in the summer of 2014 to do business with cryptocurrency firms. The bank expanded the assets on its balance sheet significantly—doubling its assets in its 2017 fiscal year to $1.9 billion—by servicing cryptocurrency exchanges and other companies who were involved in the cryptocurrency business that could not secure financing from larger, more conservative banks. Despite its rapid growth, the company maintained a small physical footprint; , the bank had only three branches, all located in Southern California. By the fourth quarter of 2022, 90% of the bank's deposits had become cryptocurrency-related, with over $1 billion in deposits being tied to Sam Bankman-Fried.
In addition to providing traditional banking services to its cryptocurrency clients, the bank operated as a clearinghouse for its banking clients; it involved itself in the business of resolving and settling transactions in real-time through its proprietary Silvergate Exchange Network. The network allowed a client to send payments in U.S. dollars from its accounts with Silvergate to those of another client of the bank without requiring an interbank wire transfer. A large number of cryptocurrency companies set up accounts with the bank to take advantage of Silvergate's relatively quick transaction settling times.
Despite conducting the majority of its business with cryptocurrency companies, Silvergate's investment portfolio was fairly conservative; the company took large positions in mortgage-backed securities as well as U.S. bonds. These sorts of assets, while reliable to be paid-in-full through their maturity date, carry risks associated with changes in interest rates; there is an inverse relationship between the mark-to-market value of a bond and the bond's yield. As interest rates shot up during the 2021–2023 inflation surge, the mark-to-market price of these securities decreased significantly. When these losses are unrealized, this does not typically cause the bank to cease operating, as the bank will receive payment-in-full under the original terms of the bond. However, if forced to sell these securities at a lower mark-to-market price, the losses on these types of assets become realized, posing significant risks to the bank's ability to continue to operate.
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