Even with headlines warning of impending doom due to bank failures and a lack of consumer confidence, most individuals need to take a deep breath, as most likely you will be okay.
The panic began with reports being published and spread in multiple news outlets over the last several days indicating that banks were failing. Where there is money, there will also be emotion. Of course, when people find out their bank is failing, they will worry about their savings, their investments and the ability to provide for their families.
There is thorough justification for these feelings of anxiety; however, if you wish to understand how this occurred, we must go back to 2021.
From 2020 through 2022, a number of technology companies were generating significant profits, raising significant amounts of money, and experiencing tremendous growth. All of this capital required a storage place, thus we have seen it deposited into banking institutions throughout the country.
Banks are institutions that do not simply store funds, but also utilize funds on deposit. They do this primarily through securities and bonds, specifically U.S. Treasury Bonds. Banks earn interest from these types of investments, pay depositors a percentage and keep everything else. This is the normal banking process.
What happened next is what truly messed up this arrangement. The bonds that were purchased by the banks in 2021 provided a very low interest return because the interest rate in all of 2021 was unbelievably low. At the beginning of 2022 when interest rates were rising sharply due to the Federal Reserve trying to slow inflation, those banks began holding older bonds with lower interest payments compared to the newer higher-interest bonds that were newly issued.
So, if those banks needed to sell their older bonds, the banks would have been at a loss. However, normally, that would not have been an extremely significant event for the banking industry.
In 2022 things began to change even more as the tech companies began pulling out their deposits from the banks to cover expenses such as payroll costs and operating costs. When that happened, that led to a number of banks, most notably Silicon Valley Bank, needing to sell off even more of those mortgages at a discount to pay back the funds that were taken out.
Once all of the large depositors noticed the losses that were incurred, fear set in. Large depositors have a real tendency to not sit around waiting for the bank to collapse – that is why they move their deposits out quickly. The higher the level of withdrawals that are done by the larger depositors, the more of those bonds the banks are going to be forced to sell, and therefore the more losses they are going to incur. This leads to even greater fear for the smaller depositors.
This is the essence of a bank run. The fear of failure leads to panic, which creates an upward spiral of liquidity problems for the bank and creates a bank run.
Where FDIC Insurance comes into play
For everyday consumers, FDIC Insurance is the most important aspect of banking. Though most U.S. banks carry or provide FDIC Insurance (as do many Credit Unions through NCUA), it assures consumers their Deposits are insured for $250,000 each, per Institution.
If your Banking Institution fails and your balance is within these limits, you will automatically receive a reimbursement of your deposits. No exceptions.
For balances exceeding that amount within a single bank, things become somewhat more complicating. However, the recent examples of Government intervention into the Banking system with regard to protecting depositor’s funds, where all Deposits were made whole to eliminate the potential of Public Panic/Hysteria, serve as evidence of the protections provided by FDIC/NCUA Insurance. Additionally, it should also be mentioned, it did not come at the cost of the American Taxpayer, but instead was absorbed by the Banking Industry.
Stock Investment Overview
If you have been observing Bank Shares, you’re not dreaming or imagining things. Several Regional Banks in particular, experienced very negative price declines throughout this process. However, if you look at the entire Market, it has remained remarkably stable during the same time.
This is why Diversification is so important. By having a common mix of Investments, Investors can reduce their risk exposure. Investing heavily in one Company’s Stock, or even a Group (Sector), can result in dramatic Financial Losses when unexpected occurrences/events happen.
Lastly, never lose sight of the fact Investing is not a sprint, but rather a Marathon. Past history has proven Markets recover from adverse price fluctuations, and remaining steadfastly commited to your strategy will yield better results than reacting emotionally.
What Should Your Next Move Be?
Provided your deposits fall under the insurance limits covered by your deposit insurance company (e.g., FDIC in the U.S.), then you’re protected. If your investments have been diversified according to both your age and your financial goals, then a short-term market disruption should not prevent you from following through on your investment strategy.
In fact, sometimes, the best financial decision is to do nothing at all.
Lessons Learned From the Chaos
Although the current events surrounding a single bank’s failure, this episode highlights the importance of understanding how to create systems so you can remain calm when things go wrong and to have systems in place in advance, so you can handle difficulties if and when they arise. Diversify your assets, learn about your protection options, and do not be ensnared by the negative headlines into making bad investment choices.
Chaos will not prevail if you are prepared to be calm when managing your money.
