What we know, and don’t know, about recent bank developments
Editorial staff, J.P. Morgan Wealth Management
- Silicon Valley Bank (SVB) and Signature Bank failed as regulators deemed them unable to meet the liquidity needs of their customers amid a rapid outflow of deposits.
- Government agencies are working to ensure that customers affected by the bank failures receive their deposits in full, as preserving public confidence in the financial system is the main focus at the moment.
- While the current situation is concerning, it’s unlikely to spiral into another global financial crisis (GFC). This is largely because bigger, systematically important banks still have diversified assets and client bases due to regulations implemented in response to the 2008 GFC.
The past week has been a whirlwind in the face of renewed market volatility and uncertainty. There have been bank failures, a quick policy response to stave off the worst case scenario of those failures, big shifts in expectations on what the Federal Reserve will do going forward and new labor market and inflation data. In short, there is a lot to unpack.
Jeanne Sun, Head of Investments & Advice for Digital Wealth, J.P. Morgan Wealth Management, was joined by Elyse Ausenbaugh, Global Investment Strategist for J.P. Morgan Wealth Management to discuss these recent bank developments and their implications for the future.
A brief overview
Amidst a backdrop of the Fed’s messaging on rising interest rates, the first domino fell last week with the collapse of Silvergate Bank, a fairly small bank that caters to the crypto industry. Shortly thereafter, SVB came into focus, with Signature Bank following a similar trend over the weekend.
By Sunday night, the Fed, Treasury Department and Federal Deposit Insurance Corp. (FDIC) issued a joint statement that all depositors at SVB and Signature would be able to access the entirety of their deposits by Monday morning – regardless if those deposits were insured or not.
Naturally, Treasury yields dropped substantially in response as the market adjusted its expectations for the path of the Fed’s policy rate moving forward. While the U.S. stock market has fallen roughly 3% over the past week (and is now back to nearly flat on the year), bank stocks have taken some of the biggest hits. To illustrate this, regional banks are down more than 20% since last week, while bigger, more systematically important bank stocks are down a still painful but more modest 10% or so.
How did this happen?
While the debate over what caused this is still going on, industry professionals agree that several factors jointly contributed to the second- and third-largest bank failures in U.S. history. “It’s important to understand the nuances of what caused these particular banks to fail, how that’s different from the GFC and how we should consider the policy response that’s already been delivered,” remarked Sun.
For starters, the market has been wrestling with volatility for some time now. SVB said it was seeing large deposit outflows from its tech-heavy clients – clients who for months in the wake of a more difficult growth and interest rate environment, had been burning through their cash.
This incident threw other customers into a panic, compelling them to pull their deposits at once. SVB ultimately did not have enough cash on hand, which triggered a run on the bank (i.e., when mass simultaneous withdrawals drain a bank of its cash). By midday Friday, they had failed and were deemed both illiquid and insolvent over the weekend. Signature Bank followed suit.
However, these banks had primed themselves for a crisis like this in a few key ways. Their overreliance on tech and startup industry clients meant their deposit bases weren’t as “sticky” or as diversified as other, bigger banks. While they did have high-quality assets, they were forced to sell them at a loss to generate cash for customer withdrawals. This ultimately caused a run on the bank, and in turn, a massive balance sheet problem.
These low capital asset ratios and relatively “slippery” client bases created the perfect storm of circumstances which led us to where we are now.
Are we headed toward another Global Financial Crisis?
Understandably, people are worried that GFC 2.0 is on the horizon in light of all this. However, our specialists disagree. “While the current situation is concerning, we don’t think it will spiral into another GFC. This is largely because the bigger, systematically important banks are far more diversified, more regulated and have less vulnerable assets,” Ausenbaugh stated. SVB and Signature failed not because of a credit event, but rather a combination of a run on deposits and the forced sale of securities on their balance sheet at a loss. Their depositors are being made whole by government agencies, who are also taking other options to maintain confidence in the financial system.
But there are other factors which lead industry professionals to believe that a GFC is unlikely to stem from this, including the following:
- SVB and Signature have unique client bases focused on a specific sector. This is in contrast to bigger banks, which typically have more diversified client bases across a range of sectors (e.g., retail, consumers, health care, etc.).
- Most U.S. banks – especially the big, systematically important ones – have healthier capital ratios and more diversified portfolios of investments. This is largely due to the Dodd-Frank Bill, which implemented stricter bank regulations in response to the 2008 GFC.
- Some of these regulations were rolled back for smaller and midsize banks in 2018, permitting them to build higher-risk portfolios and investments that leave them more vulnerable to collapse.
- These recent failures weren’t the result of poor-quality loans or assets, but a glaring discrepancy between how much cash was available and how much was ultimately needed by their clients – much unlike what triggered the GFC in 2008.
- We can’t understate the importance of the support measures jointly delivered by the Fed, Treasury and FDIC on Sunday night. Regulators stepped in quickly to ensure that both insured and uninsured SVB and Signature Bank depositors would regain access to their money on Monday.
It's clear that U.S. regulators are working to maintain confidence in the financial system. If these policies are successful, the measures should help to slow deposit outflows, and in turn prevent a scenario like the GFC from happening again.
Moving forward
As unnerving as this all can be, Ausenbaugh stresses that it’s important to remember the principles of investing. "In this environment, it’s important to stay diversified and aligned with your time horizon, risk tolerance and financial goals." Volatility comes with the territory, but this too shall pass.” While our specialists don’t think now is the time to be taking big risks, they do believe investors can continue to phase into diversified portfolios – even in a volatile market.
At J.P. Morgan, we remain laser-focused on high quality-based factors like balance sheet liquidity, strong free cash flow and a history of dividend growth. For diversified portfolios, we continue to like core bonds given their ability to help dampen volatility. Investors may also wish to consider exposure to mid-cap stocks, which typically have less exposure to banks than small-cap indices, and preferred stocks (though we favor systemically important companies over smaller counterparts).
Above all, remember that building one’s net worth is a marathon, not a sprint. Staying focused on your long-term goals is key to reaching the finish line.
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Editorial staff, J.P. Morgan Wealth Management
