Amnesia over America's banking crisis of 2023 may prove perilous

Itis not good for capitalism when bankers and others who knowingly take risks pay no price when such a risk materializes

- RAGHURAM G. RAJAN & VIRAL V. ACHARYA

Almost a year after the mini banking crisis in the US, it is worth revisiting the episode. Was it just a tempest in a teacup? Was there really a systemi threat, or was it just a problem with a few banks? Should the interventions by the US Federal Reserve and Treasury worry or comfort us? Recall that three mid-size US banks suddenly failed around March 2023. The most prominent was Silicon Valley Bank (SVB), which became the second-largest bank failure in US history (after Washington Mutual in 2008). Roughly 90% of the deposits at SVB were uninsured, and uninsured deposits are prone to runs. Making matters worse, SVB had invested significant sums in long-term bonds, the market value of which fell as interest rates rose. When SVB sold some of these holdings to raise funds, the unrealized losses embedded in its bond portfolio started coming to light. A failed equity offering then triggered a classic bank run.

It is convenient to think that these issues were confined to just a few rogue banks. But the problem was systemic.

When the Fed engages in quantitative easing (QE), it buys bonds from financial institutions.

Typically, those sellers then deposit the money in their bank, and this results in a large increase in uninsured deposits in the banking system. On the banks' asset side, there is a corresponding increase in central-bank reserves. This is stable, since these reserves are the most liquid asset on the planet and can be used to satisfy any impatient depositors who come for their money. Unfortunately, a number of smaller banks (with less than $50 billion in assets) moved away from this stable position as QE continued.