The recent months were crazy for banking sector as we saw Silicon Valley bank and many others collapse because of the bank runs.
Silicon Valley Bank became the biggest U.S. lender to fail since 2008 crisis.
That was was a stunning downfall for a lender that had quadrupled in size over the last five years and was valued at more than $40 billion as recently as last year. What’s more interesting that few days prior this bank was operating as usual, so that was a good example how fast bank run can shut down a bank.
What is a bank run?
A bank run is a situation where a large number of customers of a bank withdraw their deposits at the same time, usually out of fear that the bank is about to fail. Bank runs typically occur when there are concerns about the solvency of the bank, or when rumors about the bank’s stability start circulating among depositors.
During a bank run, customers who are afraid of losing their deposits may rush to the bank to withdraw their money, leading to long lines and even panic. If too many customers withdraw their deposits, the bank may run out of cash and become insolvent, which can lead to a collapse of the bank and cause significant economic disruption.
To prevent bank runs, many countries have deposit insurance programs that guarantee the safety of a certain amount of deposits held by each customer. Additionally, central banks can provide liquidity to troubled banks to prevent them from running out of cash during a crisis.
Historical examples of bank runs
In 1929 stock market crash, American depositors began to panic and started withdrawing their money as they wanted to hold physical cash. A succession of bank runs on thousands of banks occurred in the early 1930s in a domino effect.
However, bank runs still occur. More recent example of significant bank runs include those on Silicon Valley Bank in the US and Credit Suisse in Switzerland.
In response to the bank runs of the 1930s, the U.S. government set up several regulatory mechanisms to try to prevent bank runs, including establishing the Federal Deposit Insurance Corporation (FDIC), which today insures depositors up to $250,000 per banking institution.
Which means that if you had $500,000 deposit in any US bank, if the bank goes down you will still get back $250,000 of your deposit. So here’s one tip for you guys. If you have $500,000 in a bank, it’s best to split this money between two banks $250,000 each, this way 100% of your money will be insured by FDIC.
Silicon Valley bank run
Some blame Federal Reserve’s aggressive interest rate hiking regime. Others say the bank failed to manage risk properly. Some say the firm would have been fine had it not spooked depositors by publicly revealing its struggles.
They’re likely all a little bit right. While interest rates and risk management are mathematical explanations of how the bank got into hot water in the first place, what ultimately did in SVB was a bank run — a rush among depositors to withdraw their money. The phenomenon depends more on behavioral psychology than financial reality.
As one financial psychology professor said: “A social contagion happens. It comes down to our herd mentality, our tribal brain.” “It’s like a mass delusion that becomes a reality. We create our own crises.”
Silicon Valley Bank kicked off 48 hours of chaos last week when it announced it had sold $21 billion worth of bonds at a $1.8 billion loss and planned to cover the shortfall by selling stock and preferred stock.
After the announcement, prominent venture capitalists began to raise alarms about the situation on social media, some of them urging startups — the bulk of Silicon Valley bank’s clientele — to pull their deposits.
Get out early, and you’ll keep your money, the thinking went. In the event of a bank run, waiting around could mean you wouldn’t be made whole.
People listened. Customers pulled more than $42 billion in a single day in what House Financial Services Committee Chairman Patrick McHenry called “the first Twitter fueled bank run.” With share prices plummeting, SVB was unwilling to find an investor and couldn’t cover its withdrawals.
Twitter or not, it was typical of what can happen when people are faced with widespread uncertainty about their finances.
Can bank run happen to your bank?
It is possible for a bank run to happen to any bank, including the bank you use. If there are concerns about the financial health or stability of the bank, or if rumors circulate that the bank may be in trouble, customers may become worried about the safety of their deposits and attempt to withdraw their funds en masse. This can lead to a bank run, which can have severe consequences for the bank, its customers, and the broader economy.
However, it is important to note that most banks have measures in place to prevent bank runs and manage the fallout from such events. For example, banks typically hold reserves to cover withdrawals, and many countries have deposit insurance programs that protect customers’ deposits up to a certain amount.
So, it’s unlikely for two reasons. One, regulators have shown a willingness to step in quickly. The Federal Deposit Insurance Corporation seized deposits at Silicon Valley Bank on Friday, and by Sunday, Treasury Secretary and Fed Chair Jerome Powell and FDIC announced that all of SVB’s customers would be made whole.
Here you have the government stepping in and saying, ‘No, we’ve got this. You’re covered,’ in an attempt to stop the herd from running off the cliff.”
Plus, for most Americans, the FDIC already provides a safety net. Bank deposit accounts, including checking and savings accounts, certificates of deposit and money market accounts, are insured by the FDIC for up to $250,000 per person, per bank and per ownership category.
“The vast majority of bank customers have cash balances that are below the FDIC-insured amount”.
In other words, you and just about everyone you know don’t have to panic about whether your deposits are safe., unless you have more than $250,000 deposited per one bank.
The reason customers at SVB panicked is because they’re not the average people depositing their personal money. The vast majority of them were startup companies whose cash holdings were well in excess of the insurable amount.
In fact, as of 2022, some 94% of SVB’s domestic deposits were uninsured, according to an analysis by S&P Global. It means that if Silicon Valley Bank would have gone down, only 6% of depositors would get their money back by FDIC insurance.
So, what can you do to protect yourself from losing money if something similar happens to your bank. Firstly, don’t panic and think clearly. Secondly, spread your money within several banks or you can simply open additional savings account next to your current account and split the money between those accounts.
The idea is to not hold more than $250,000 in one bank or one bank account, then you will be fully insured by FDIC and will get back your money in full if something happens to your bank. If you don’t have more than $250,000 stored in your bank, then you have nothing to worry about.
Always remember what Warren Buffet said about investing. His first rule to investing is: never lose money. Second rule is never forget the rule number one.
