Originally Posted by
Whirlin
Couple things.
FDIC Insures 250k per depositor, per bank, per ownership class. You and your wife could have two individual accounts, a joint account, a money market account and have a limit of $1m
There's two major types of failures that occurred in the past week. Liquidity Risk and Interest Risks. Liquidity Risks is what occurred at Silvergate and Signature banks. They both had ~>10% deposits in the crypto market, which crashed, and liquidity became a concern. Silicon Valley Bank went through hypergrowth and... was honestly a pretty shoddy bank. They dwelled more on Deposits than they did about actually making money and being a bank.
There's a lot to unpack in those two lines... so lets step back for a moment.
How to banks even make money?
An individual deposits $100. The bank can then loan $75 to someone else. That loan of $75 will earn them $80 over the course of a year, and now they have $5 profit. Because they were using the individual's money, they offer them an interest rate on their deposit, so the individual now has $101, while the bank has earned $4. This concept also refers to total money supply in the macroeconomic sense. Because that $75 that they loaned out is deposited into another account at another bank, or spent on the market, whose recipient in turn deposits those $75 into a bank, who can loan out $66, so on and so forth. The end result is that $100 can produce about $400 as you follow the money.
How banks earn that $4 margin is dependent upon how they invest that money. The best example of this is from It's a Wonderful Life, when the money was used as mortgages to build houses. Nowadays, there are additional options. Not only direct originations of collateralized and uncollateralized loans, but more companies have been created to handle the origination of these loans which can be sold to banks, so that they're paying the independent party to do the origination due diligence. Additionally, asset classes of particular securities/etc can be consolidated bought/sold as needed. Banks should stratesfy their investments for a variety of maturation dates, interest rates, and risk postures to ensure that they're properly leveraging against market conditions. Which will bring me to my next point.
Dodd Frank established several requirements onto banks for their risk management strategies. Typically, a new bank dwells predominantly on operational and regulatory risks. This includes things like fraud identification, detection, red flag reporting for potential money laundering, and ensuring that back end systems can't have the Super Man 2 exploits where someone pockets a fraction of a cent until it's billions of dollars. This control posture management/etc is all verified by the FDIC. FDIC is typically at every bank at least once per quarter, and usually in constant contact with executives from the bank. And if they see something they don't like, they can red line any potential bank mergers or acquisitions. The FDIC is looking for maturing internal programs to identify and manage risks, and will hold alll three lines of risk (business line, risk management, and audit) accountable to execute on effective practices. Each of the 8 OCC categories (Regulatory, Credit, Interest rate, Liquidity, Pricing, Transaction, Strategic, and Reputational... with a 9th of foreign exchange depending on the bank operations) of risk typically requires a different mitigation approach. Many are categorized into Operational risk (Regulatory, Credit, Transaction, Strategic and Reputational, Pricing), while the others are financial risks (Interest Rate, Liquidity). Operational risks are typically documented via identification of risks, and their associated controls, evaluating the control effectiveness, aggregate, aggregate. The Financial risks are typically identified and tested via risk scenario assessments. The most prevalent is the Monte Carlo simulation, where there's a variety of environmental changes that keep getting worse and worse to determine your risk posture to defend against adverse actions.
Under Trump's Regulatory rollback efforts, his March 2020 changes introduced two things: 1: He reduced the fractional reserve of lending from 10% down to 0%. (2): He removed the requirements for risk scenarios to be conducted as part of the FDIC oversight for Small and Medium Sized banks. To perform scenario analysis does typically require at least 1 six figured FTE on staff, which does have a larger effect on small and medium sized banks. Everyone agreed upon the larger impact the smaller the organization, and agreed with an overall reduction in requirements depending on bank size, which aligns to many of the FDIC testing methodologies. However, it was fully removed, and not reduced. Therefore, as a result of the changes, there is no periodic regulatory requirement to conduct Interest Rate or Liquidity Assessments in order to comply with FDIC requirements. The rest of the requirements stayed in place, and are generally a high threshold on banks. So going above and beyond costs meant it's typically not done.
In regards to the reduction of the marginal lending reserve requirement. It's easy to think of... "Well, even if the requirement was now 0%, I want to remain at 10%", and thinking that banks may 'do the right thing' in only lending up to what they're comfortable doing. However, without a more formalized Liquidity assessment to determine likelihoods of these needs, it became more of a manner to potentially drive profits, and take risks. With a publicaly traded company, it's less about turning a binary profit. It's about turning the most profit compared to your peers for your size.
The best analogy I can think of is that the ability to reduce the marginal retention to 0% is like enabling an engine to go even more full throttle than it could before. The Removal of requirements for Interest Rate Assessments is like removing the warning signs of a big curve up ahead, and the removal of liquidity assessments is like removing your speedometer, so you don't know how fast you're truly going or the risks of going off the curve.
As a result, banks found themselves non-liquid and unable to make depositors' demands for funds.
Why? The root cause for Signature and Silvergate bank was mostly due to Crypto currency deposits accounting for a decent portion of their deposits. With crypto tanking, folks sought to withdraw. Crypto, by definition, carries a larger liquidity risk than a savings account, it's a completely different asset class! As a result of Silvergate's failures, SVB likely was housing a lot of funding for crypto startups, which may have also needed to pull funds from. None of the banks were liquid enough because they didn't consider the maturation of investments and properly hedge and diversify.
So... next steps... why bail them out?
We're at a 0% retention rate with many smaller banks not giving credence to liquidity risks. This can potentially have a domino effect if folks lose faith in the financial markets. Folks see one bank fail, they withdraw all their money from another bank, realizing the potential liquidity risks that exist at that other bank, causing it to fail, so on and so forth. The FDIC has a large buffer of money. Banks all pay into the universal banking funds/etc, which are able to cover these three bank failures. This is protection against future bank runs and lose of customer confidence. Failure to do so could in turn cause more banks to fail, more FDIC payouts, and may run over on the current FDIC supplies, which COULD cause a taxpayer hit after their reserves are depleted.
Barney Frank, the Frank in the Dodd-Frank, put most of the burden and blame on the Crypto-currency collapse, and he's not wrong. Warren puts a lot of the blame on the lack of regulations and required oversight into Interest Rate and Liquidity Assessments, and she's not wrong either. I don't think I've seen enough blame in the media put on the 10% retention rate down to 0%, and it's overall impact on inflation in general and risks to banks.
The reality is that we're in a capitalist society, by definition, it is all about the CAPITAL. The raw ability to purchase goods. Money is made from Money. Financial "Products" are the earlier access to capital at a cost, like a mortgage. Failure to have access to capital just entrenches worse class warfare than we already have.
All of that being said, anyone that had insider information and was able to profit off of the events, should absolutely be prosecuted to the fullest extent possible. A LOT of folks are back in the job market as a result of these collapses, are there are additional widespread concerns when institutions fail.
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