The U.S. banking system is facing a crisis of confidence as customers withdraw nearly $100 billion in deposits from banks, especially smaller ones.
The main trigger for the massive outflow of deposits was the collapse of two prominent banks Silicon Valley Bank and Signature Bank. These banks failed due to their exposure to risky commercial real estate loans and cryptocurrencies .
Silicon Valley Bank and Signature Bank suffered a sharp decline in value amid rising interest rates and regulatory scrutiny. The failure of these banks sparked a panic among depositors who feared losing their money or having limited access to it.
According to Federal Reserve data, bank customers collectively pulled $98.4 billion from accounts for the week ended March 15, 2023. The bulk of the money came from small banks, which saw outflows of $120 billion, while large institutions saw deposits increase by $67 billion.
The withdrawals brought total deposits down to just over $17.5 trillion and represented about 0.6% of the total.
The withdrawal of deposits poses a serious challenge for banks, as they rely on deposits to fund their lending activities and maintain their liquidity ratios. When deposits shrink, banks have to reduce their lending or borrow from other sources, such as the Federal Reserve or other banks, at higher costs. This can affect their profitability and solvency, as well as their ability to meet customer demands.
To prevent a further erosion of confidence in the banking system, regulators have taken several steps to reassure the public and support the banks.
Treasury Secretary Janet Yellen, Federal Reserve Chairman Jerome Powell and more than a dozen other officials convened a special closed meeting of the Financial Stability Oversight Council on Friday, March 24. A readout from the session indicated that a New York Fed staff member briefed the group on “market developments”.
“The Council discussed current conditions in the banking sector and noted that while some institutions have come under stress, the U.S. banking system remains sound and resilient,” the statement said. “The Council also discussed ongoing efforts at member agencies to monitor financial developments.”
The Fed also raised its benchmark interest rate by another quarter percentage point on Wednesday, March 22, to combat inflation and signal its confidence in the economic recovery. Powell said during a news conference that the Fed has the tools to protect depositors when there’s a threat of serious harm to the economy or to the financial system.
“You’ve seen that we have the tools to protect depositors when there’s a threat of serious harm to the economy or to the financial system, and we’re prepared to use those tools,” Powell said. “And I think depositors should assume that their deposits are safe.”
Powell noted that deposit flows “have stabilized over the past week” following what he called “powerful actions” from the Fed to offer a buffer to investors.
The question remains whether these measures will be enough to restore trust in the banking system and stem the tide of withdrawals. Some analysts have warned that commercial real estate could be the “next shoe to drop” as property values decline and defaults rise. Others have pointed out that money market mutual funds have seen their assets increase over the past two weeks, up $203 billion to $3.27 trillion, indicating that some investors are seeking safer alternatives to bank deposits.
The U.S. banking system is facing a critical test of its resilience amid unprecedented challenges and uncertainties. The outcome will depend on how well regulators, banks and customers can work together to overcome this crisis and restore confidence in the financial system.