The New Bank Run. Fingers Not Feet!
Hopefully that is a question none of us ever have to ask.
First, here is an article by Forbes that describes in simple detail how a bank works and the different types of banks.
3 Reasons for Bank Failures
Other than external Market Risks, which also must be mitigated, there are 3 major reasons that a bank can fail.
Credit Risk – people/businesses may default on loans; banks have to assess the risk associated with Non-Performing Loans (NPL), the value of the collateral pledged and successfully manage the risk. – Example: Global Financial Crisis 2008
Interest Rate Risk – “the exposure of a bank’s…earnings and capital to adverse changes in market rates…. excessive interest rate risk can threaten banks’ earnings, capital, liquidity, and solvency.“ – Example: Silicon Valley Bank (SVB), 2023
Liquidity Risk – being ‘cash strapped” for any period of time can create the need to quickly sell assets to cover expenses including account withdrawals. Example: SVB, without enough cash to cover withdrawals, had to sell Bonds at a $1.8B loss.
This increased the Liquidity Risk and resulted in a lack of confidence in the bank which led to the bank run.
First Republic Bank
What happened at First Republic Bank, the 14th largest in the US with 93 branches in 11 States?
Both Fitch Ratings and S&P Global Ratings downgraded First Republic Bank’s credit rating on Wednesday, 3/15 over concerns that depositors could pull their cash.
According to Allison Morrow at CNN Business, “About two-thirds of First Republic’s deposits were uninsured…”
Meaning those accounts were over $250,000. The average, or even above average, person is unlikely to have that much in a deposit account but businesses frequently do and must have access to their accounts to pay employees, suppliers, etc.
Fellow Bankers to the Rescue
In an historic and unprecedented action, the top 11 US banks, led by JPMorgan, jointly agreed on Thursday, 3/16 to deposit $30 Billion into First Republic in an effort to stabilize the situation.
It remains to be seen whether that will be successful. Moody’s downgraded First Republic on Friday.
Banking is about Trust and Confidence and Risk.
When depositors lose confidence in the bank – or the banking system – they perceive their risk to be unacceptable.
Fear replaces Trust.
They believe their only option is to withdraw their money as quickly as possible.
How fast can your money run?
A long way, in less than a nano-second – and no lines.
Which can lead to a run on the bank. The outcome is a ‘self-fulfilling prophecy.’
The fight against inflation and rising interest rates have caught some banks in a very tight squeeze. For some, it will be a ‘permanent reminder of a temporary situation.’
Managing Risk – it’s just as critical in Investing as in Banking.
We deposit our hard earned money in the bank and expect them to take care of it for us.
We don’t have the same point of view when buying the stock of a company with our hard-earned money. The risk must still be managed. It’s up to us.
If you owned First Republic and were using a Trailing Stop Loss to manage risk at a generous 15%, you would have stopped out at $98 rather than riding it down to $23 in just two weeks and you would be $75/share richer!
As an investor, consider Defensive Sectors like Consumer Staples right now. You can find them in the Detailed Search in TrendingStocks.IO
And as banking stocks go, JPM might be worth considering. It’s superbly run and led the charge to save confidence in the system.
And remember – Ride Your Winners; Cut Your Losses!
Sources: various including FDIC, Bank of America, yahoo finance, CNN Business and more.
