If you’re trying to understand why Silicon Valley Bank and Signature Bank have collapsed and what it means for your money in a bank, you may find yourself opening a Pandora’s box of complicated financial jargon.
If you’ve never heard of terms like systemic risk, banking contagion and more, you’re certainly not alone. Fortunately, bank collapses are relatively rare, so many of these terms are uncommon.
But understanding some of these terms can help you unpack what’s happened over the past week (you might even impress your Tinder date).
A bank run occurs when most people who have deposited their money in a particular bank want to withdraw it at the same time. Because banks make loans with depositors’ money, they don’t have all their money on hand.
Although banks are required to set aside a portion of depositors’ money in cash reserves that they cannot lend out, it is not enough to ensure that everyone can withdraw their money at the same time.
Silicon Valley Bank and Signature Bank experienced bank runs stemming from fears that the banks were about to fail. Finally, when most depositors tried to withdraw their money at once, the Federal Deposit Insurance Corporation forced the banks to close.
When the FDIC took over SVB and Signature Bank it created new quasi-banks known as bridge banks.
The FDIC creates bridge banks when a bank fails so that it can transfer any of its remaining assets and act on depositors’ behalf to recover as much of their money as possible. Like regular banks, bridge banks have their own boards of directors. But unlike regular banks, the members of their boards of directors are appointed by the FDIC.
Bridge banks are also temporary and designed to last until another bank buys them or all their assets are liquidated, meaning they revert to cash.
Systemic risk exception
The FDIC, the Treasury Department, and the Federal Reserve jointly announced that SVB and Signature depositors would get all their money back, even if they exceed the FDIC’s normal $250,000 insurance limit due to a “systemic risk exception”.
In the context of banking, systemic risk occurs when there is a fear that the problems or failure of one bank will cause a domino effect throughout the banking industry. The government determined that the failures of SVB and Signature, which would have left many uninsured depositors without immediate access to their money, posed a risk large enough to merit extraordinary action.
Loan to deposit ratio
Banks make a profit by lending some of the money they receive through deposits. However, regulations prevent them from lending out all their deposits at a given time, as this would mean customers would not be able to withdraw money.
One way to measure the stability of a bank is to look at the amount of money they lend to depositors. This is known as the loan-to-deposit ratio. The higher the ratio, the riskier the bank.
SVB loan/deposit ratio
The ratio is not a telling sign of a bank’s risk position. For example, SVB’s ratio stood at 43%, according to the bank’s mid-quarter update. By mid-2022, the ratio was above 60% across the entire US banking industry, according to Data from S&P Global Market Intelligence.
The ratio also does not indicate whether depositors’ money is being used in different ways besides making loans. In the case of SVB, the bank ran into problems because too much of its depositors’ money was tied up in investments made in US bonds.
Elisabeth Buchwald is USA TODAY’s personal finance and markets correspondent. You can follow her on Twitter @BuchElisabeth and sign up for our Daily Money newsletter here
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