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.

The second lesson is to understand and take advantage of FDIC (and National Credit Union Administration (NCUA), the credit-union equivalent) limits. Essentially, the federal government insures bank deposits up to $250,000 per depositor per bank. So, if you have more than $250,000 in cash, it would be wise to split it up between different banks so it is all insured. While this is not always possible, it is generally a good practice.

The third lesson is that the government will often do more than it is required to do. The FDIC was only required to back up $250,000 of depositor money, but it essentially stepped in and insured all SVB deposits to prevent systemic risk to the financial system. While concerned about the moral hazard of “bailing out” businesses, the government felt that letting the bank—and its investors—fail without hurting depositors was the proper place to draw the line in these circumstances. The government has done similarly unexpected things in the past, such as the recent three-plus-year student-loan holiday. While you cannot count on these sorts of interventions, you can take advantage of them when they do occur. This particular action should make you a little more comfortable to keep more than FDIC limits in a single bank. It would not be surprising to see future Congressional bills and regulatory action directed at raising FDIC limits, either with or without requiring an insurance premium to be paid by the depositor.

The fourth lesson is that even successful businesses need back-up banking plans. The problem with the SVB crisis that required the government to step in was that it was about to affect the lives of everyday people. Their employers banking at SVB were profitable businesses with plenty of cash. However, through no fault of their own, they could not access that cash to make payroll and were facing possible loss of that cash. If they had some of their money elsewhere, even at a second bank, this would not have been nearly as much of a problem.

Cautious with Cash

The fifth lesson is that banks are not great places for you to invest large amounts of cash. While there have been times the last few years when a high-yield savings account paid more than money-market funds, that is no longer the case. As of this writing (in March 2023), the best money-market funds are paying over 4.5 percent while most high-yield savings accounts are only paying around 3.6 percent and the average savings account yield is 0.35 percent. If you have a need to hold large amounts of cash for any length of time longer than a few days, you are far better off linking your bank account to a high-quality money-market fund at one of the big mutual fund companies and moving money back and forth as needed. Not only will you earn a higher yield, but there is no risk of a bank run on a money-market fund. Money-market funds do not engage in fractional banking.

Banking is an important part of all our financial lives. However just like our currency, the fractional-banking system requires a certain amount of trust. When that trust is eroded, severe economic disruption can occur for society as a whole. To minimize risk, be careful how you and your businesses interact with that banking system.

Dr. Dahle blogs at whitecoatinvestor.com and is a best-selling author and podcaster. He is not a licensed financial adviser, accountant, or attorney, and he recommends you consult with your own advisers prior to acting on any information you read here.