What's wrong with the banks

Only ten days ago you might have thought that the banks had been fixed after the nightmare of the financial crisis in 2007-09. Now it is clear that they still have the power to cause a heart-stopping scare. A ferocious run at Silicon Valley Bank on March 9th saw $42bn in deposits flee in a day. SVB was just one of three American lenders to collapse in the space of a week. Regulators worked frantically over the weekend to devise a rescue. Even so, customers are asking once again if their money is safe.

Investors have taken fright. Fully $229bn has been wiped off the market value of America's banks so far this month, a fall of 17%. Treasury yields have tumbled and markets now reckon the Federal Reserve will begin cutting interest rates in the summer.

Share prices of banks in Europe and Japan have plunged, too. Credit Suisse, which faces other woes, saw its stock fall by 24% on March 15th and on March 16th it sought liquidity support from the Swiss central bank.

Fourteen years since the financial crisis, questions are once again swirling about how fragile banks are, and whether regulators have been caught out.

The high-speed collapse of SVB has cast light on an underappreciated risk within the system. When interest rates were low and asset prices high the Californian bank loaded up on long-term bonds. Then the Fed raised rates at its sharpest pace in four decades, bond prices plunged and the bank was left with huge losses. America's capital rules do not require most banks to account for the falling price of bonds they plan to hold until they mature.

Only very large banks must mark to market all of their bonds that are available to trade. But, as SVB discovered, if a bank wobbles and must sell bonds, unrecognised losses become real.

Across America's banking system, these unrecognised losses are vast: $620bn at the end of 2022, equivalent to about a third of the combined capital cushions of America's banks. Fortunately, other banks are much further away from the brink than SVB was. But rising interest rates have left the system vulnerable.