Question

I was shocked to see bank runs in March 2023. I thought those went away after regulatory changes in the Great Depression. What takeaway should there be from the troubles that Silicon Valley Bank (SVB) and other banks had during March 2023?

Answer

In March 2023, depositors of SVB engaged in a classic “bank run” that resulted in the Federal Deposit Insurance Corporation (FDIC) stepping in and putting the bank into receivership. There were a number of factors that made SVB particularly susceptible to this problem, but all banks are susceptible to a bank run. The reason for this is because the money you lend to a bank does not stay at the bank. The bank lends it out. Our banking system is also a “fractional banking” system, meaning that the bank can and does lend out even more money than it takes in in deposits. This all works just fine, unless all the depositors want all their money back all at once. Obviously, the more a bank lends out, the more money it can make in the good times, but the higher risk of a bank run. So regulations have been put in place over the years that limit how much a bank can lend out, and what kinds of assets and how much of them it must keep to pay the demands of depositors.

In the case of SVB and many other banks, the assets the bank holds are relatively safe Treasury bonds (Treasuries). However, while Treasuries are guaranteed by the U.S. government, a holder of a Treasury must hold it until maturity to be guaranteed to receive their entire principal back. If they sell it prior to maturity, it will be sold for a gain if interest rates have fallen and for a loss if interest rates have risen. Since interest rates went up dramatically in 2022, Treasuries that must be sold early, especially long-term Treasuries, will be sold at a severe loss. This made it even more difficult for SVB to raise funds to meet depositor demands during a bank run.

Lessons Learned

There are number of lessons to learn from this situation. The first is to avoid buying long-term assets with short-term debt. Bank deposits are the ultimate in short-term debt, since they can be called at any time. A bank has to do this to a certain extent, of course, but in your personal life it should be avoided. Homeowners doing this en masse with adjustable-rate mortgages contributed to the Global Financial Crisis of 2008. If SVB had not “reached for yield” by buying long-term Treasuries and had stuck with short-term Treasuries instead, it would not have been in such a mess.