2023

REASONS FOR THE

CRISIS OF REGIONAL
BANKS IN THE U.S.

IN DEPTH ANALYSIS OF THE REASONS FOR THE FALL OF SILICON

VALLEY BANKS, FIRST REPUBLIC BANK, AND SIGNATURE BANK
SETIABUDI, CAITLYNN HANS (115753)
 Introduction

Regional banks in the United States, have always been one of the foundations of local
economies and communities in the US. Now, they find themselves in the midst of a profound
crisis. In the year 2023 only, there have been 3 different major regional banks that went
bankrupt.

The implications of this crisis reach far beyond the realm of finance, touching the lives of
countless Americans and impacting the broader banking industry. Henceforth, understanding
the root causes of this crisis is not only imperative for the financial sector but also essential for
the well-being of communities nationwide.

This paper is dedicated to a comprehensive exploration of the reasons behind the crisis facing
regional banks in the United States in the year 2023, examining the intricate interplay of
economic, regulatory, and technological factors that have coalesced to challenge the very
existence of these institutions.
 Analysis of the Reasons behind the Crisis of U.S. Regional Banks

The turbulence within America's regional banks began on March 8 when Silvergate Capital
Corporation, a key player in the cryptocurrency realm, announced plans for voluntary
liquidation. This unexpected move mainly stemmed from the fallout following the
cryptocurrency exchange FTX's crash.

Within a span of two days, another shockwave hit when US regulators closed down Silicon
Valley Bank, an institution synonymous with support to technological startups and venture
capital firms in and around the San Francisco Bay Area. The incredulity surrounding this event
owed much to Silicon Valley Bank's notorious yet steady presence in American banking
history.

As though these tremors weren't enough, within less than a week on March 12, New York
regulators shut down Signature Bank; marking the fourth-largest bank failure ever seen in US
history. Signature Bank's operations were notably similar to Silvergate Capital Corporation in
terms of focusing on cryptocurrency customers. Not too long afterwards, First Republic Bank
- known for providing wealth management and brokerage services - also landed squarely
amidst this brewing crisis due to fear among customers and investors that it could be next down
the line of failures.

Despite receiving a $30 billion infusion from 11 of America's leading banks towards mid-
March, First Republic Bank couldn't sustain itself. On May 1, 2023, US regulators took control
of First Republic Bank, eventually selling off its deposits and most of its assets to JP Morgan
Chase (The 2023 US Regional Banking Crisis Is far from Over, n.d.).

This tumultuous period entered the annals of US banking history as three out of the four most
significant bank failures. First Republic Bank, Silicon Valley Bank, and Signature Bank were
now second, third, and fourth in these infamous rankings. Collectively, the assets held by these
three fallen giants totaled $532 billion, surpassing the combined $526 billion held by the 25
banks that failed in 2008.

The reason why it is very important to be discussed is due to the impact caused by these
bankruptcies to the economy. Not only impacting the industries that each of the bank relates
to, they are also affecting the economy through their major roles in the banking system through
their relations with other banks. For example, the collapse of Silicon Valley Bank has
significant implications for the broader technology industry since they financed many of the
most innovative and high-growth companies in the sector. As a result, it is much more
challenging for these companies to secure the financing they need to continue to innovate and
grow (Barron, 2023). In addition to the impact on the technology industry, Banks and financial
institutions around the globe are rocking from the effects due to how vital Silicon Valley Bank
was to the banking industry as a whole. This bank crash has shaken people’s trust in the U.S.’s
power in tech and finance. Henceforth, it has thrown a big question mark over the country’s
role as a global bigwig.

Based on the huge impact that the bankruptcies of these banks possess, the reasons can be
divided into two parts; the common one and the specific one. Delving deeper into the
commonalities among these banks reveals some unsettling trends:

1. Each enjoyed a phase of rapid expansion powered by short-term funding prior to

collapse.
2. Increasing interest rates
When it comes to the relationship between interest rates and bond prices, they move in
opposite directions. That means, when interest rate ascends, bond prices descend.
Henceforth, regional banks which invested in long-term bonds when the interest rates
were dramatically lower suffered on-paper losses with the surge of interest rates.
A case in point is the Silicon Valley Bank. With rising interests, their bonds have
depreciated in value making them risk-prone investments. Consequently, their clients
faced financial constraints and started to remove their funds from their accounts
altogether which one of the causes as to why they went bankrupt.
3. Their portfolios were heavily tilted towards long-dated Treasury bonds and mortgage-
backed securities. This strategy exposed them to massive unrealized losses amidst
rising interest rates between 2022-2023 (The 2023 US Regional Banking Crisis Is far
from Over, n.d.).
4. Each had a significant weightage of uninsured deposits and other short-term liabilities,
which could be – and indeed were – withdrawn readily at a moment's notice. This panic-
induced mass withdrawal by uninsured depositors triggered their eventual downfalls.
As an example, on March 9, customers withdrew $42 billion in a single day from
Silicon Valley Bank which caused them to declare bankruptcy on the next day.
The more specific reasons for the bankruptcies are as follows:

1. Irresponsible management decisions made by individual banks.

The Federal Reserve and various banking experts have consistently warned, especially
post the 2008-2009 financial calamity, that banks holding a substantial reserve of U.S.
government bonds could potentially get embroiled in problems. However, this notion
has not been really taken seriously by numerous bank managements. Instead of taking
lessons from history to heart, these banks are actively fuelling unchecked growth,
exhibiting poor risk oversight, and relying heavily on uninsured deposits. A case in
point is the fall of Signature Bank which was mainly caused by poor management. They
failed to understand the risks of its concentration in the crypto sector, they invested in
an abnormally large share of uninsured deposits, they failed to understand their liquidity
situation which put them into a high liquidity risk, and they lacked the adequate FDIC
oversight. These issues were building up without significant solutions which led them
to their bankruptcy.

2. FED’s Misjudgements
One of the most important factors contributing to the current US banking crisis is the
FED’s single-minded focus on controlling inflation, which has led it to raise interest
rates too high and too quickly over the past year. Since March 2022, there have been
ten successive interest rate increases, with 0.25% being the latest increment. Coupled
with this surge is a large-scale contraction in the Fed’s balance sheet-a strategy known
as quantitative tightening.

As a consequence, regional banks are grappling with multiple hazards, including

significant unrealized losses on long-dated securities, major depositor outflows that
favor larger banks and money market funds, alongside diminished profits due to
escalated funding costs.

The rise in interest rates has motivated depositors to remove funds from regional banks
to seek higher returns elsewhere. In order to cover these deposit outflows, regional
banks have found themselves forced to sell their long-term bonds prematurely at a loss.
 Silicon Valley Bank serves as one prime example of this situation. They were docked
about $1.8 billion after parting with $21 billion worth of securities. This caused a major
shaking of confidence among its customers in the venture capital community
concerning the bank’s liquidity status.

After the failure of Silicon Valley Bank, Signature Bank’s depositors also panicked due
to the bank’s high proportion of uninsured deposits.

3. Regulatory Rollbacks and Lax Oversight

This is one of the reasons that has not been strictly looked for in terms of banking crisis.
The Trump administration notably diluted the power of the definitive 2010 Dodd-Frank
Wall Street Reform and Consumer Protection Act. This legislation, crucially
implemented to fortify financial stability in the wake of the 2008 crisis, was
significantly affected. In a bipartisan agreement in 2018, the U.S. Congress amended
this act leading to a substantial decrease in the number of banks that would come under
strict regulatory requisites. These stringent conditions included robust capital and
liquidity rules, meticulous resolution plans for potential crises, rigorous stress testing
exercises, and adherence to other high standards. This dilution meant that numerous
banks which could have benefitted from such comprehensive scrutiny escaped being
under this advantageous pressure.

This recent legislative amendment has increased the threshold for heightened regulatory
standards from $50 billion to $250 billion. In the wake of these modifications, both
Silicon Valley Bank and Signature Bank managed to dodge these new regulations. At
first glance, this step may appear non-deadly as its motive is to alleviate regulatory
burdens imposed on small and medium-sized banks.

Nonetheless, specialists theorize that barring these amendments could have provided a
greater likelihood of circumventing the latest bank failures. If institutions like Silicon
Valley Bank, Signature Bank, and First Republic Bank were subject to things like living
wills and stringent stress tests, their latent risks birthed from rising interest rates and
excessive reliance on uninsured deposits could have been spotted and tackled sooner,
hence stopping their downfall.
In response to the bank failures, the Fed tried to rebuild the economy by implementing the
following:

1. Federal Deposit Insurance Corporation (FDIC)

The FDIC said it would make all depositors who banked with Silicon Valley Bank and
Signature “whole,” this means they are ensuring that no customer would lose access to
their money.
2. The Fed introduced a new special emergency lending initiative.
This is designed to proffer loans of up to one year at eased rates (4.83 percent as of
March 13) to other banks, savings associations, credit unions, and depository
institutions. This aid would be provided in exchange for government-backed assets used
as collateral. Distinguishedly, the Federal Reserve agreed to accept these assets at their
initial value; such an agreement allows banks to mitigate losses (Foster, n.d.).
3. Fed’s Discount Window
The Federal Reserve’s discount window serves as a key monetary policy tool, typically
managed by central banks, that permits eligible institutions to borrow funds from the
central bank. This borrowing generally occurs on a temporary, short-term basis,
designed to surmount transitory liquidity shortages triggered by either internal or
external disturbances. One significant alteration in this context involved eliminating the
additional so-called "penalty" rate charged to banks that chose to borrow funds from
the Fed’s discount window (Foster, n.d.).

Of particular note is that this is not to be construed as a bailout in any terms. The taxpayer will
not shoulder any of the losses associated with the resolution of Silicon Valley Bank. Rather,
the funds needed to cover lost deposits will emanate from both the assets of these banks and
insurance premiums paid for coverage by banks that are FDIC members. It should also be
clarified that these actions target only depositors; shareholders or investors will not receive
reimbursements (Foster, n.d.).

“While the Fed has been talked about a lot in the past year, until today it has been in the context
of monetary policy,” says Greg McBride, CFA, Bankrate chief financial analyst (The 2023 US
Regional Banking Crisis Is far from Over, n.d.). “But today, the Fed acts in the capacity of an
even more important role, the lender of last resort, to make sure banks and credit unions have
access to whatever cash they need without needing to sell high-quality assets that may be
trading for less than face value due to the sharp increase in interest rates.” (The 2023 US
Regional Banking Crisis Is far from Over, n.d.).

Even though these measures have helped reduce the problem of liquidity strains and the
potential risk of bank runs in the short term, it is still insufficient to address some of the
underlying vulnerabilities that could contribute to increased level of panic in the regional
banking sector. These underlying vulnerabilities include losses on existing assets, rising
funding costs, and a deposit flight away from small and medium-sized banks to big banks.

Additional to the present circumstances, it is insightful to recognize that in our modern era of
social media and digital banking, mere rumours can incite withdrawals, amounting to billions
of dollars from any size of bank, with mere mouse clicks or smartphone swipes. These 'digital
bank runs' can be exceedingly unpredictable and challenging to curtail.

Such an aspect, often underestimated, holds potent influence over a bank's potential insolvency.
It is a testament to the profound ways in which technology and communication platforms can
impact financial stability and should not be discounted when considering factors leading to a
bank's bankruptcy.

Regarding what the future may hold, it is uncertain what actions the government will take. To
this point, the Biden administration has proposed an array of potential enhancements to banking
regulation and oversight. This includes reversing some of the rules that were relaxed in 2018.
Nevertheless, these initiatives are expected to face substantial hurdles from a House of
Representatives controlled by Republicans.

In such a politically divided Congress, the likelihood of increasing the FDIC’s deposit
insurance limit appears rather low. Hence, while changes are potentially beneficial, they
remain, at present, difficult to implement amidst prevailing political ideologies.
 Conclusion

In conclusion, the bankruptcy of U.S. regional banks in 2023 can be attributed to a convergence
of several factors. Foremost among these was the Federal Reserve’s stringent efforts to control
inflation, which led to abrupt and steep hikes in interest rates. Coupled with a quantitative
tightening policy, these measures resulted in significant unrealized losses for regional banks
on long-date securities/

The interest rate hike then prompted a chain reaction-depositors began withdrawing funds from
regional banks to seek higher returns elsewhere. To cover these withdrawals, banks were
compelled to prematurely sell their long-term bonds at a loss.

Another contributing factor was legislative changes that lifted the threshold for enhanced
regulatory standards from $50 billion to $250 billion, exempting banks like Silicon Valley
Bank and Signature Bank from heightened regulations. Experts have opined that if these
modifications were not enacted and the original standards maintained, the subsequent financial
disaster could potentially have been avoided.

Further compounding issues was an over-dependence on uninsured deposits by many of these

banks along with poor financial risk management. All these factors created a perfect storm
leading up to the unfortunate bankruptcy of many U.S. regional banks in 2023.

Even though there are some steps taken to soften the impacts, the underlying problems have
not yet been resolved. Coupled with the high use of internet and spreading of hoax, the future
of banking industry in the U.S. is unknown.
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