SVB similarities to 1930s bank collapse: Fed economists

After the Depression-era bank runs that caused thousands of financial institutions to fail, the government began doing something different in the 1930s—it created the FDIC and began insuring deposits. This is intended to make people feel confident in the banking system, and less likely to take their money.

But that deposit insurance is up to $250,000 for each depositor, to be exact. So when Silicon Valley Bank and Signature Bank collapsed in March and shipped ripple effect across the banking sector, many are targeting banks shares of unsecured deposits which amounted to millions and billions as one of the main causes of panic, along with the Federal Reserve increase in interest and depositor panic burned on social media.

Although SVB and Signature are covered by the Federal Deposit Insurance Corporation, the nature of their deposits—many uninsured and in a small number of industries—are similar to 9,000 banks which failed in the 1930s, according to a recent blog post of economists at the Federal Reserve Bank of New York.

The authors argue that like Depression-era banks in small rural communities, SVB and Signature deposits were held by a small number of like-minded people, many of whom worked in the same industry and often who talk to each other. Banks also fail to control the narrative, increasing the risk of a troubled bank.

With their “concentrated and uninsured deposit bases,” Silicon Valley Bank and Signature Bank look “similar to the small rural banks of the 1930s, before the creation of deposit insurance,” the Fed economists wrote.

Similar to the 1930s

During the early years of the Great Depression, thousands of bank failures led to $1.3 billion in losses for depositors. But the damage is likely exacerbated by the lack of deposit insurance—individual bank customers are more likely to withdraw their money from a bank at the first signs of trouble.

“Before the FDIC acted, the massive demand for money by panicked depositors often dealt the fatal blow to banks that might otherwise have survived,” the FDIC’s website state. Many of the failed banks were dedicated to rural communities, with the majority of their depositors being local and working in the agricultural sector.

Although SVB and Signature banks do not cater to small urban farmers, Fed economists point out that their depositors are also part of tight-knit communities—in finance, technology and law.

“SVB and SB have a depositor base that looks local, with depositors reportedly interacting with each other in their regular business transactions,” they wrote. “SVB depositors are connected through venture capital networks and SB depositors are connected through law firm networks.”

Before it collapsed, SVB made a name for itself as the bank of choice for California’s startup and venture capital elite. Nearly half of all startups are venture-backed in the US bankers with SVB, according to the bank itself, and its big gamble to concentrate on technology, which for many years seemed like a good bet, finally came back to bite this as a significant number of its clients are affected go up VC funding last year.

Signature also has a problem with concentration, it seems just one of the banks to offer services to crypto companies after many others started turned in the sector earlier this year. Signature deposits are more diverse than Silvergate, a bank that is very focused on cryptocurrency collapsed too in March, but still relies on customers from a relatively small pool of industries, as Signature is more concentrated in banking services for real estate and law firms.

Because most of the clients of both banks are companies, most deposits also exceed the FDIC’s insurable limit of $250,000. In fact, both banks have some of the highest proportions of unsecured deposits in the entire banking sector. Among banks with at least $50 billion in assets, SVB had the highest share of unsecured deposits at 93.8%, while Signature was fourth with 89.3%, according to S&P Global Market Intelligence.

Like most bank depositors who know each other professionally, the bank run happened almost overnight, said the account owners. spread terror on social media and instant messaging platforms such as TwitterSlack, and Whatsapp, with some venture capitalists told their portfolio companies in group chats to move their funds out of SVB “as quickly as possible,” increasing the risks of concentration.

Economists at the New York Fed argue that the failure of communication and transparency in banks is mainly responsible for the sudden run, while advising other institutions to focus on managing risk accounts that may threaten lose confidence in the future.

Just like the small rural banks that failed a century ago, banks like SVB and Signature with highly concentrated and local customer bases must master information management to restore trust. before the panic, justified or not, weakens the financial health of banking institutions, the New York Fed economists wrote.

“Both SVB and SB, like small rural banks before the creation of the FDIC, should be well aware of the importance of managing information about their balance sheet,” they said. “Looking forward, our work highlights that banks should remain aware of, and proactively manage, information about the balance sheet risks presented to their depositors, especially in times of financial stress.”



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