Three banks in the US recently failed: Silicon Valley Bank, Silvergate Bank and Signature Bank. It seems that we have a situation that in the literature is called “financial contagion” or “flight from banks”, but everything is much more complicated than it seems. Fear is spreading across financial markets, with older banks also under pressure in Europe (eg BNP, Credit Suisse).

Case description

The first thing to note is that the three banks in question are NOT RELATED. That is, we do not have interbank contagion. We have a different situation that needs to be understood correctly. The reasons for the collapse of banks are different, the path of manifestation is similar, more precisely, the mass withdrawal of customers from the respective banks.

It must be said that no bank can withstand mass withdrawal of customer deposits, no matter how serious the bank is, no matter how safe and well managed it is. The reason is the way banks work. Depositors’ money can be withdrawn at any time, but the bank places the money in different forms, which involve a slower withdrawal process. A normal time balance is achieved by balancing deposits and withdrawals on one side with normal withdrawals on the other. In troubled times, banks place some of their assets in securities that can be liquidated quickly to pay out when withdrawals exceed the norm. But these securities are not very profitable, and therefore banks place money mainly in the form of loans, with a much greater benefit than securities. Transferring these credits to third parties is possible, but it is always an expensive and slow process. Simply put, money can now be claimed by depositors, but the bank can only claim money from borrowers when it is due.

Silvergate Bank or Silvergate Group was a bank that relatively specialized in cryptocurrency. Its main client was FTX, a powerful player in the crypto market, whose fall was the starting point for the fall. It is probably not a surprise to anyone that a bank specializing in risky operations would fail.

There is not enough information about SIGnature Bank, we only know that it is a bank that works in the cryptosphere and has serious liquidity problems.

Silicon Valley Bank was a bank that specialized in entrepreneurship and technology. In this bank, most of the deposits were accounts of technology companies, money from investors to start a business. The bank’s investments were mostly in US government bonds, the value of which fell significantly due to the increase in interest rates by the Fed. In practice, the bank’s investments quickly became hopeless. It was enough that for one reason or another there was a surge in payments, for the bank to be forced to sell securities at a loss, for it to become obvious that the bank was insolvent. With a relatively small number of customers with very large deposits, the probability of such an event was extremely high. In this case, the main reason for the fall is the increase in the interest rate of the Fed, and the favorable factor is the type of depositors with whom the bank works.

It should be noted that SVB is the central node of the financial network of Start-Up business in the USA, operating up to 50% of the capital contributed by the founders and investors of these companies. The contagion effect in the field of technology can be very dangerous, as a cascade of bankruptcies of companies that are supposed to be the future of the American economy is possible.

So we have two banks that we can consider risky from the start because they have been in the cryptocurrency space, active because of their volatile and risky nature, and an investor bank in the technology space.

Common to all these phenomena is inflation itself and measures to combat it. These banks grew up in a world of cheap credit and plenty of cheap capital and collapsed when the cheap capital disappeared. In addition to management errors, which will emerge later when investigations reveal exactly what mistakes were made and who is responsible for them, there is an inevitable systemic cause—the paradigm shift caused by inflation.

Possible effects

One of the main problems highlighted in connection with the bankruptcy of the State Bank of Ukraine is related to government bonds in the banks’ portfolios. In practice, holding government securities is risky for banks’ ability to cope with shocks, especially when increases in interest on securities depreciate the securities portfolio. Any shock that leads to the need to sell from the portfolio of names turns into an immediate loss.

It sounds complicated, but the effect is simple, perhaps it will reduce the demand for government bonds. This will lead to a depreciation of securities and an increase in interest on new securities, so we will likely see a sharp reduction in the ability of governments to finance deficits.

The consequences of the bankruptcy of SIGnature Bank and Silvergate are different. In fact, we are witnessing the last acts of the old crypto-bubble. As the fundamental idea once again proves that investment fads are not a good indicator of the future, this is a new iteration of the dot.com lesson.

.In the short term, it is possible that some banks that are already in trouble will also become bankrupt. There is a lot of talk about Credit Suisse in this regard, and we just witnessed the $50 billion bailout of CS by the Swiss Central Bank.

Why does everything happen?

As always, disasters are the result of a series of consecutive and cumulative errors. In the case of the three US banks, we can talk about deregulation of banking supervision by the Trump administration, but even if that may be a factor, it is not a significant factor. We can talk about client structure or misplacement, we can talk about poor risk management, but in fact these are contributing factors to the fall, not the root causes.

The essence of the problem is inflation, which puts pressure on the liquidity of depositors of all types, generating, on the one hand, a reduction in the savings of the population, a reduction in excess liquidity in some companies, and devaluing a significant part of the portfolio of government securities of banks, securities that were reliable for a long time investment

All banks were affected by inflation and certain changes in the yield on financial assets. Perhaps a paradigm shift leads to unpredictable changes, and we see the network break down first at the weak points and then gradually towards the central points. The force exerting pressure on this network is inflation.

Is the collapse of the international financial system approaching?

There are voices that say that the entire financial system may collapse, especially if the series of bank failures continues and develops towards systemic banks. The possibility of such a phenomenon is always there, but I, for all my pessimism, do not consider such a probability to be high.

In the modern monetary system, money flows between banks. Neither in banks that have gone bankrupt, nor in banks that will go bankrupt, withdrawal of deposits is not carried out in cash, but by transfer from one bank to another. This means that the system does not behave like dominoes, but like a system of connected vessels. If the vessel remains empty, the liquidity in it is effectively transferred to another vessel. With each bank that fails, the remaining banks accumulate more liquidity and are able to buy assets at a greater discount, becoming stronger and more stable. Rather, we observe the phenomenon of concentration of power in the banking sector, elimination of the weak in favor of the strong. When the banks get stronger, they will pass on the losses to the depositors and shareholders of the failed banks and buy their financial assets at liquidation prices with huge profits.

The need for credit is huge, the supply decreases with each bank bankruptcy. This means we are likely to see interest rate hikes again in favor of the surviving banks. Essentially, the system will pass on losses and capitalize profits. Some of the losses will be covered by the states, which will increase the credit needs of the states and further accelerate the demand for credit.

I believe that what we perceive as the financial crisis is a huge bingo or jackpot, a fantastic opportunity that is probably hotly contested right now. Of course, there will be enough losers, there will be people who will lose deposits or income, but the system itself will not be destroyed.

This is where the advantage of digitizing currency and demonetizing gold seems to become apparent. In the old system based on gold, banks could disappear entirely because gold can exist independently of banks, whereas today’s currency cannot actually exist in relevant quantities outside of a banking system. Read the full article and leave comments at Contributors .US