Banking Crisis: Small Banks Hit by Massive Cash Withdrawals

Americans have withdrawn nearly $120 billion in deposits from U.S. small banks in the week marked by the collapse of Silicon Valley Bank.

The sudden collapse of Silicon Valley Bank on March 10 created chaos in the banking industry. 

This failure, which is the second-largest failure of a bank in American history after Washington Mutual in 2008, has shaken investors to the point of creating a crisis of confidence around the entire banking sector.

Santa Clara, Calif.-based SVB was the go-to lender for many tech companies. It provided specialized financial services, industry expertise, a valuable network, and a strong reputation. It also offered a range of financial services, tailored specifically to the needs of startups, such as venture debt, corporate banking and asset management. These services are designed to help startups manage their finances, optimize their cash flow and scale their businesses.

Created in 1983, Silicon Valley Bank, which presented itself as a "partner for the innovation economy,” offered higher interest rates on deposits than its larger rivals, to attract customers. The company then invested the clients' money in long-dated Treasury bonds and mortgage bonds with strong returns.

Deposits Continue to Fall

This strategy had worked well in recent years. The bank’s deposits doubled to $102 billion at the end of 2020 from $49 billion in 2018. In 2022, deposits increased to $189.2 billion. 

But everything turned upside down when the Federal Reserve began to raise interest rates, which made existing bonds held by SVB less valuable. As a result, the bank had to sell the bonds at a discount to cover withdrawals from its customers. In selling these bond positions, SVB had to take a significant loss of $1.8 billion.

Due to this loss, SVB suddenly announced that it needed to raise additional capital of $2.25 billion, by issuing new common and convertible preferred shares. This decision caused panic and a run on the bank.

Since then, fears of the ripple effect have spread like wildfire, threatening the banking sector, despite the fact that too-big-to-fail banks have been subject to strict regulations since the financial crisis of 2008.

In addition to SVB, fears of contagion have already led to the closure of Signature Bank in New York and also the acquisition of Credit Suisse by UBS for the modest sum of $3.24 billion. 

The panic surrounding banks in the markets is also accompanied by outflows from smaller banks. According to new data from the Federal Reserve, Americans withdrew $120 billion in deposits from small banks during the week ending March 15. 

Deposits with smaller banks totaled nearly $5.456 trillion, compared to nearly $5.576 trillion in the week ended March 8. It should be noted that deposits have not stopped decreasing since the beginning of the year, but this is the first time that withdrawals have been so high. 

'Sound' And 'Resilient'

The big banks appear to be the big winners of this banking crisis, since they have recorded inflows. Deposits with major banks totaled $10.74 trillion in the week ended March 15, up $67.4 billion. The previous week, i.e. before the collapse of SVB, deposits had fallen by $76 billion with major banks.

In total, Americans withdrew $98.4 billion from banks in the week ending March 15. The total amount of deposits thus amounted to $17.5 trillion compared to $17.6 trillion the week before.

Despite these outflows, regulators insisted on reassuring that the American financial system remained sound. U.S. Secretary of the Treasury Janet L. Yellen convened a meeting of the Financial Stability Oversight Council in executive session by videoconference on March 24.

"The Council discussed current conditions in the banking sector and noted that while some institutions have come under stress, the U.S. banking system remains sound and resilient," a statement from the meeting published by the Treasury department read.