The last two months have been chaotic, unnerving and problematic for financial institutions, not only in the U.S. where 3 of the 4 largest bank failures in the nation’s history have occurred, but around the world as Credit Suisse was rescued by Swiss banking regulators and merged with UBS. This level of bank failures has made customers worry that a bigger banking crisis is coming, according to a JD Power survey released at the end of April. What does all of this mean for credit unions? Let’s break it down.
On March 10 the FDIC had to rescue Silicon Valley Bank, who experienced an old fashioned “run” on the bank, when large depositors worried they might not be able to gain access to their funds and began pulling billions out of the bank. The FDIC took the rare step of closing SVB on Friday morning, rather than announcing after hours on Friday evening as they traditionally do, as SVB was unable to meet withdrawing depositor demands. That same weekend, Signature Bank in NYC was closed on Sunday, primarily from rapid growth, large uninsured deposits and a focus on cryptocurrency, which has experienced its own collapse and crisis over the past 18-24 months.
Then on May 1, the FDIC announced that First Republic Bank in San Francisco, was seized and sold to JPMorgan Chase in an FDIC assisted transaction, where JPMorgan would share losses with the FDIC and would receive $50 billion in financing from the FDIC. As with SVB, the immediate problem First Republic Bank faced was a massive withdrawal of $100 billion in big uninsured deposit balances, but the bank’s problems were also a result of a wrong way bet on interest rates. As the Wall Street Journal reported: “A focus on America’s coastal elite helped First Republic become one of the most valuable U.S. banking franchises. Big deposits from customers with lots of cash funded low-rate jumbo mortgages to wealthy home buyers. Ultra-low interest rates and a pandemic savings boom supercharged the bank’s growth.”
When the Fed began raising interest rates in 2022 to cool the highest inflation rates the U.S. had experienced in 40 years, customers began to demand higher yields on deposits while values of fixed rate mortgages and investments began to plummet. This interest rate risk mismatch was a significant problem at each of the three big bank failures in the U.S. The projected cost to the FDIC of the failure of these three banks is close to $35 billion. Banks will pay for these losses through higher FDIC insurance premiums, and that will likely be passed along to their customers. Fortunately, no taxpayer assistance is expected this time, unlike the crisis in 2008.
It was also interesting that the outside auditors of both SVB and Signature Bank gave clean opinions and did not point out the multi-billion-dollar losses hidden in the “Hold to Maturity” Investment portfolios of the banks, who failed literally days after their year-end audit opinions were issued.
What do these failures point out to us? What should we think about in the world of credit unions? Several points are obvious:
- Interest Rate Risk is real and significant, especially after living through a historic time of virtually the lowest rates in the last 70 years. Understanding that rates won’t stay low forever, and taking action to protect from the inevitable increase should have been on every financial institution leader’s list of priorities. Regulators and outside auditors should have been focused on this reality as well, including noting the potential exposure of various scenarios of interest rate increases on the value of fixed-rate assets.
- Bank Management was blamed in each of the three failures, for not taking appropriate action and not responding to regulator criticisms (and regulators admitted they should have pushed the banks board of directors on the interest rate risk and rapid growth risk).
- Self-assessments are a critical part of risk management and should be performed at least quarterly in high-risk situations and no less than annually.
Back in the 1980’s rapid growth in excess of 20%-25% annually was cause for a special exam by the banking regulators to understand what was causing the rapid growth, what precautions management was taking to safeguard against taking undue risk (i.e. looser underwriting standards to put the rapid growth in deposits to work), and to ensure that management was not attracting unstable deposit sources. To think that banks like Silicon Valley Bank could experience a near tripling of their deposit base from $60 billion in 2020 to $175 billion in 2022 would have brought an immediate and intense scrutiny of the bank in the 1980s.
Why wasn’t that the same over the past couple of years? Changes in regulators, new younger staff, and the regulators did not institutionalize the risks that were faced the last time we experienced high inflation as a country and experienced a crisis in the health of our financial institutions.
A related impact of the collapse of SVB, Signature Bank and the well documented troubles of First Republic Bank that resulted in the FDIC seizing it on May 1, has rattled consumer confidence in their financial institutions, according to a report by J.D. Power released on April 27, 2023, entitled “Recent Bank Failures Strain Consumer Faith in U.S. Banking System.” The report goes on to say: “As if inflation and fear of a recession weren’t enough to stoke the fears of banking customers in the United States, a new concern has emerged: The overall stability of the U.S. banking system.”
According to J.D. Power, 29% of banking customers say they are “very concerned” with the stability of the banking system. Among those who were aware of the SVB and Signature Bank failures, that number rose to 34%. Just over half of banking customers are aware of any bank being forced to close. J.D. Power reported “The high-profile bank failures have also stoked misconceptions among retail bank customers about bank failure risk and deposit protection.”
The good news is that credit union members had the lowest level of overall concern about the stability of the banking system, with 19% being concerned.
What does this mean for us in the credit union industry? We need to help our member-facing employees understand what has happened with the failure of SVB, Signature Bank and First Republic Bank, and why this is not likely to be a problem faced by any credit unions. Each of these big banks had very large levels of uninsured deposits, making them high risk for a deposit run by worried customers, which is what happened at each of them. Credit unions have primarily member deposits that are mostly fully insured by the Share Insurance Fund. We also need to communicate that to our members, either proactively, or whenever we get a question from a member.
We also need to model how much interest rate risk we have in our credit unions, especially as we have originated more fixed rate mortgages over the past ten years than any time in our collective history, and make sure that we are not overly exposed to increasing rates on our deposits, while holding fixed rate assets.
The other good news from this banking crisis, is that it should be winding down at this point. First Republic Bank was the lone remaining bank that had grown substantially, had a very large percentage of uninsured deposits, that experienced a massive deposit loss ($100 billion in a couple of weeks after the SVB failure) and was limping along looking for help. Once members are no longer hearing about risks of failing banks on a near daily basis, that should begin to reassure them.
Bottom line, we need to learn from these mistakes, strengthen our interest rate risk management and risk management assessments, and prepare for questions from members to help them know that credit unions are a safe place for them.