Bank Risk 2024
This is a mid-year update on U.S. bank risk.
First off, let's review the events of the past year since the 2023 bank run. The bank run of March 2023 collapsed several mid-sized U.S. banks in a short span of time, beginning with Silicon Valley Bank during the week of March 7th, 2023. The ultimate causes of that bank run were blamed on high unrealized losses from long-term bond investments, Fed rate hikes which re-priced bond portfolios AND caused a sharp increase in deposit costs, and thirdly an historically unprecedented proportion of uninsured deposits. Of course, rate hikes are a function of every late stage business cycle, but what sets this era apart from all others are the large unrealized gains from bond losses combined with the large proportion of uninsured (> $250,000) individual bank deposits. Both of these risk factors stem from the serial monetary bailouts that have taken place since 2008 and were exacerbated during the pandemic. During the bank run of March 2023, the FDIC was able to find buyers for each of the failed banks, which limited the cost of bailing out the banks. However in May of 2023 they put out a report indicating that in the future 100% bailout of all depositors is highly unlikely:
May 1, 2023
Uninsured Deposit Risk:
Page 9:
"Following the 2008–2013 banking crisis, the reliance by the U.S. banking system on uninsured deposits grew dramatically, both in dollar volume and as a proportion of overall deposit funding.20 From year-end 2009 through year-end 2022, uninsured domestic deposits at FDIC-institutions increased at an annualized rate of 9.8 percent, from $2.3 trillion to $7.7 trillion [Page 11:]...which is 43 percent of domestic deposits"
Page 9-10:
"Finally, since the onset of the COVID-19 pandemic, demand deposits as a share of domestic deposits have increased sharply; demand deposits include both insured and uninsured deposits"
Interest Rate Risk:
Page 37:
"Mismatch in asset and liability maturities exposes banks to repricing risk, one type of interest rate risk. The extent of mismatch in asset and liability maturities is important in assessing a bank’s exposure to interest rate risk"
Page 38: [Graph inset]
"FIGURE 5.1 Loans and Securities That Mature or Reprice in More Than 1 Year Rose Dramatically During the Pandemic"
FR: The net result of the large increase in loans and securities with maturities more than 1 year was these massive unrealized bond losses arising from Fed rate hikes. Below is a chart from the March 2024 FDIC quarterly banking report showing the current state of unrealized losses on securities maturing in more than 1 year:
Chart 7:
The remainder of the article lays out various options for FDIC reform, none of which were considered by Congress during this past year. The option that the FDIC recommended was the "Targeted Approach" which would provide 100% recovery for all business accounts, but restrict personal accounts to the $250,000 limit. This approach would still expose trillions of dollars to potential losses in a major bank run. In any event, none of the recommendations were implemented which leaves the current paradigm in place.
Page 3:
"Limited Coverage maintains the current system of deposit insurance and does not, by itself, address the run risk associated with high concentrations of uninsured deposits"
As we know, the 2023 bank run was contained. There are two major reasons why the bank run didn't spread. First and foremost was the widespread belief that the Fed would begin cutting rates in 2024 which would take pressure off of borrowers and banks. Secondly of course was the speculative AI bubble which led to a de facto easing of financial conditions while concentrating risk in a handful of massively overvalued Tech stocks. One year later and both of those conditions are now on thin ice. So far, the Fed has NOT cut rates and is still on the fence as to any rate cuts in 2024. And of course, the AI speculative bubble has gone parabolic and is now in the early stages of imploding.
A few weeks ago, the FDIC put out another May quarterly report to provide a one year update on the 2023 banking crisis:
May 17th, 2024
..."Faced with growing contagion in the system, the Boards of Directors of the FDIC and Federal Reserve voted to recommend that the Secretary of the Treasury, in consultation with the President, make a systemic risk determination under the Federal Deposit Insurance Act with regard to the resolutions of SVB and Signature Bank"
The systemic risk determination enabled the FDIC to extend deposit insurance protection to all of the depositors of SVB and Signature Bank, including uninsured depositors"
This experience has focused our attention on the need for meaningful action to improve the likelihood of an orderly resolution of a large regional bank under the FDI Act without the expectation of invoking the systemic risk exception"
In other words, there was no action by Congress to protect uninsured business bank accounts, but the FDIC is moving forward with plans NOT to invoke the systemic risk exception in the future.
What investors seem to forget about 2008 is that when the initial banking dominoes started falling, global risk assets spiked in anticipation of rate cuts. Which is what has been happening this year - risk ON rally in front of expected rate cuts. However, as we know back then it was an end-of-cycle bull trap:
All of which sets the table for a very likely renewed and worsened bank crisis by the Fall of this year.
