Why More US Banks could Collapse

Since the 2008 financial crisis, a total of 542 banks have failed, including prominent institutions like Silicon Valley Bank, Signature Bank, and First Republic. These failures have raised concerns among experts, who suggest that more banks could be at risk. Consequently, it is crucial to understand the current situation and ensure the safety of your money.

Philadelphia's Republic First Bank closed its doors in 20124. While bank failures are not uncommon, the recent struggles faced by banks are not solely due to the big Banks. One reason for their current challenges is their vulnerability to interest rates, which have reached the highest levels in over two decades. Following the Federal Reserve's decision to raise rates at the fastest pace since the 1980s in March 2022 to combat inflation, borrowing has become more expensive. Mortgage rates are now at their highest in over 20 years, and interest rates on business loans, auto loans, and credit cards have also increased. This has had a significant impact on consumers, as borrowing has become more costly. Additionally, banks are facing challenges as debt becomes more expensive, leading to fewer people borrowing from them and some defaulting on their loans. Furthermore, some banks are losing depositors to high-yield savings accounts and money market funds offering rates as high as 5%. While consumers can benefit from higher interest rates, banks that wish to retain deposits must offer more competitive rates. Lastly, banks that invested in long-term bonds are also feeling the effects of the current economic climate.

When interest rates were lower, older bonds are now less valuable due to their lower yield. It is evident that newer bonds with higher yields are more desirable. While banks may be facing challenges at the moment, it is important to understand the impact on your deposits. When you deposit money in a bank, it is not simply stored as cash in a vault. Instead, the bank utilizes most of the funds to lend out and earn interest or invest in other assets. This practice is known as fractional reserve banking. Therefore, your money is not physically present in the bank. This arrangement can lead to problems if a bank lacks effective risk management. Economic shifts can catch a bank off guard, potentially resulting in the risk of failure. In such cases, the bank may struggle to fulfill withdrawal needs or repay borrowed funds. This situation can arise when a bank incurs significant losses from loans, investments, or rapid withdrawals, commonly referred to as a bank run. Currently, smaller regional or community banks face the most pressure and vulnerability. These banks are typically less diversified in terms of their depositors and borrowers. However, they play a crucial role in providing essential services to small towns and communities. They cater to small businesses, startups, smaller landlords, home buyers, farmers, and individuals who may face challenges in obtaining loans from major banks. In the event of failure, these smaller banks may be acquired by larger banks. For instance, JP Morgan Chase acquired a majority of First Republic's assets.

In 2023, the issue at hand is the consolidation of banks, which can result in smaller business owners having limited access to banking services. This ultimately harms local businesses and communities. However, even if you don't utilize these smaller banks, it is still important to care because it can have an impact on the overall economy. Here's why: when small businesses and startups lack access to funds, it hinders economic growth. Additionally, the collapse of a bank creates fear and has ripple effects, such as depositors withdrawing their funds from smaller banks altogether. The recent collapse of US banks has raised concerns about significant financial challenges. Take Silicon Valley Bank as an example. It faced issues due to poor risk management, a lack of diverse customers, and mainly serving tech startups and venture capitalists. During prosperous times, the bank had ample cash flow, which it reinvested in long-term bonds when interest rates were low. However, the tech sector's volatility and expensive debt made it difficult for startup founders to secure funding and loans. Consequently, they increasingly relied on their deposits, triggering a bank run. To meet withdrawal demands, the bank had to sell bonds at a loss, causing a ripple effect. Shortly after, Signature Bank faced a similar fear-based bank run due to its exposure to tech and crypto, along with a high volume of uninsured deposits. While the tech and crypto sectors faced challenges in 2022 and 2023, the current sector of concern is commercial real estate. The combination of decreased demand for office space and high interest rates has made this asset class riskier. In 2024, nearly a trillion dollars in commercial real estate loans are set to mature, and renewing these loans in a higher interest rate environment raises questions about landlords' affordability. Commercial real estate foreclosures have already increased by 117% compared to last year. This is why some advocate for the Federal Reserve to begin cutting rates.

Jerome Powell recently emphasized that banks with high exposure to commercial real estate loans and uninsured deposits are at the greatest risk. The first bank failure of 2024, Republic First Bank, was a result of its significant commercial real estate exposure. However, the current stress on banks is not as severe as it was during the 2008 financial crisis. Regulators now have more experience in managing risk and contagion. Data also shows that less than 7% of bank failures since 2007 led to losses for uninsured depositors. To protect your money, ensure that your bank offers FDIC insurance deposits, which guarantees up to $250,000 in your account in case of a bank failure. If you have more than that amount, consider splitting your accounts or moving them to a different bank to stay within the insured limit. While predicting bank failures is challenging, taking these precautions can help safeguard your funds.