The 2023 Banking Crisis: what caused it and who is to blame?

March 2023 saw the beginning of the worst series of banking collapses since the Great Recession. With regional banks First Republic, Silicon Valley Bank (SVB) and Signature Bank making up the second, third and fourth largest banking failures in American history. The extraordinary series of collapses began with SVB who, as of December 2022, had incurred unrealised losses of $15 billion on their collapsing bond portfolio. This led to a storm of doubt from depositors who began to withdraw money at rapid rates, leaving the bank helpless and being forced into insolvency. This was the first domino in a series of banking collapses which shook markets and spread fear among dispositors. So, what caused the banking crisis and who is to blame?

The economic backdrop for these circumstances can be explained by two things: inflation and interest rates. Since the start of the pandemic, the US Federal Reserve has accelerated quantitative easing (printing money), with the Federal Reserve’s assets increasing from $4.2 trillion in 2020 to over $8.3 trillion in April 2023 in order to provide liquidity and support to the US economy. The increase in the Fed’s assets has flooded the economy with cash and, along with major geopolitical factors, has led to inflation. Inflation has been growing menacingly since the pandemic, with both food and fuel reaching all-time highs. In order to limit the monetary supply and decrease inflation, the federal reserve has raised interest rates to a 16 year high of 5.25%. This rate hike massively devalued previously owned US Treasury Bonds which were paying out at a much lower interest rate. SVB had a major interest in these long term bonds and there portfolio was massacred. SVB accountants attempted to hide these losses by reporting the bonds on their balance sheet at cost, rather than market value. After depositors and investors took fright over their portfolio’s exposure, it forced the bank into insolvency; having to sell the bonds at major losses. The collapse of First Republic and Signature bank can be attributed to similar failure’s to adjust to changing interest rates.

Another major factor in the failure of the regional banks is the lack of regulatory scrutiny faced by the banks. In 2010, the Dodd-Frank banking legislation (designed to avoid a repeat of the 2008 crash) required that banks over $50 billion in assets undertake federal stress tests and maintain certain levels of capital. In 2018, the US Congress, after being lobbied by regional banks, raised the capital requirements for regulation to $250 billion, allowing SVB and other regional banks to avoid federal stress tests. This made the temptation for avarice and incompetence irresistible; proven by severe risk management failures which allowed massive exposures.

It is hard to know whether we should be worried about more banking failures. Although one thing that is certain is that high interest rates are here to stay. Money is no longer cheap, and the increasing cost of debt will undoubtedly affect more than just the regional banks. After acquiring First Republic from its collapse JPMorgan chief executive Jamie Dimon exclaimed that, “this part of the crisis is over,” and that the baking system is, “extraordinarily sound”. While risks linger and markets remain apprehensive, investors will be hoping that Dimon’s assessment is right.