Why has the interest rate hikes caused midsized banks to fail (3 so far) in the US but NOT small banks? Note: I know why the banks failed just why the reasons don’t seem to affect smaller banks!
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Midsize banks are generally large enough to invest in investment markets. That leaves them exposed to the same macroeconomic issues that large national banks must also navigate. But on the other hand, they’re still smaller and not as well capitalized to weather storms; or alternatively, they try to make riskier bets in order to get better returns.
Small banks may only operate a handful of locations in a few cities or counties. Their business is so small that they don’t get involved with more speculative investments. That tends to make them dull from an investment perspective and slow to grow, but insulates them a bit from economic downturns since they’re more interested in the day-to-day business of bank services such as customer deposits and small loans.
That’s not to say small banks are *immune* to increasing interest rates. Small banks probably close with some amount of regularity. But neither do they represent some kind of larger risk that something like SVB or First Republic did, so they don’t get mentioned in news.
A large bank is able to take risks but is large enough to cover their own risks, so they’re safe.
A small bank is unlikely to take risks because they have fewer assets, so they’re (relatively) safe.
If a mid-sized bank takes some risks, they’re not big enough to necessarily cover their risks. But taking risks is what can grow the bank, so some of them will ultimately take a shot at it. If it’s a bad pick, they can lose everything.
Midsize banks are generally large enough to invest in investment markets. That leaves them exposed to the same macroeconomic issues that large national banks must also navigate. But on the other hand, they’re still smaller and not as well capitalized to weather storms; or alternatively, they try to make riskier bets in order to get better returns.
Small banks may only operate a handful of locations in a few cities or counties. Their business is so small that they don’t get involved with more speculative investments. That tends to make them dull from an investment perspective and slow to grow, but insulates them a bit from economic downturns since they’re more interested in the day-to-day business of bank services such as customer deposits and small loans.
That’s not to say small banks are *immune* to increasing interest rates. Small banks probably close with some amount of regularity. But neither do they represent some kind of larger risk that something like SVB or First Republic did, so they don’t get mentioned in news.
A large bank is able to take risks but is large enough to cover their own risks, so they’re safe.
A small bank is unlikely to take risks because they have fewer assets, so they’re (relatively) safe.
If a mid-sized bank takes some risks, they’re not big enough to necessarily cover their risks. But taking risks is what can grow the bank, so some of them will ultimately take a shot at it. If it’s a bad pick, they can lose everything.
Small banks are equally at risk in this market. These other answers aren’t correct
All banks turn short turn deposits into longer term loans and profit on the differential rates.
Smaller banks tend to have less skilled management, weak modeling, and more concentrated depositor bases. JPMorgan and the fdic say that smaller banks also tend to be undiversified in their loan portfolios with 4.4x the exposure to commercial real estate and business loans. So, giant banks who also do investment banking or brokerage also have diversified income streams. (not that that is helping Schwab atm)
https://www.jpmorgan.com/wealth-management/wealth-partners/insights/risk-watch-the-composition-of-small-bank-loans
Jpm has been doing a series of articles reviewing the financial sector. It’s not a mystery as to why they’re gobbling the failing banks, as they ate the Bear.
Small banks are equally at risk in this market. These other answers aren’t correct
All banks turn short turn deposits into longer term loans and profit on the differential rates.
Smaller banks tend to have less skilled management, weak modeling, and more concentrated depositor bases. JPMorgan and the fdic say that smaller banks also tend to be undiversified in their loan portfolios with 4.4x the exposure to commercial real estate and business loans. So, giant banks who also do investment banking or brokerage also have diversified income streams. (not that that is helping Schwab atm)
https://www.jpmorgan.com/wealth-management/wealth-partners/insights/risk-watch-the-composition-of-small-bank-loans
Jpm has been doing a series of articles reviewing the financial sector. It’s not a mystery as to why they’re gobbling the failing banks, as they ate the Bear.
These banks tended to have larger-than-average deposit size and a less diversified business model, as well as weaker risk management practices. They also bought bonds at a time when interest rates were lower. When interest rates began climbing last year, the value of their bonds declined. Because banks must state the value of their bond as they would sell in the current market (called mark to market accounting). This makes the bank’s balance sheet look bad. When that happens, many customers who have deposits greater than the $250,000 insured by the FDIC start withdrawing their money from the bank, which is called a bank run. That can lead to a bank collapsing.
These banks tended to have larger-than-average deposit size and a less diversified business model, as well as weaker risk management practices. They also bought bonds at a time when interest rates were lower. When interest rates began climbing last year, the value of their bonds declined. Because banks must state the value of their bond as they would sell in the current market (called mark to market accounting). This makes the bank’s balance sheet look bad. When that happens, many customers who have deposits greater than the $250,000 insured by the FDIC start withdrawing their money from the bank, which is called a bank run. That can lead to a bank collapsing.
The bank failures over the last six weeks were caused by a combination of 1) a lot of deposits withdrawing at the same time causing 2) the banks to sell bonds at a loss. To understand why some banks did or didn’t fail, you need to look at the makeup of deposits, and the types of loans they made.
Silicon Valley Bank and First Republic had a dangerously large share of uninsured deposits from tech startups. These are very similar companies, and they all started withdrawing money together. Almost all other banks (small, large, AND midsized) have a more diverse set of depositors, and many more deposits from retail clients like you and I that are insured by the FDIC.
SVB and First Republic took these deposits and made fixed-rate mortgage loans, and bought fixed rate bonds. While other banks (of all sizes!) have some of these assets, most banks make a lot of business loans and also issue credit cards. The key feature of these loans is that the interest rate changes (not 100% of the time, but it is extremely common). When interest rates go up, fixed rate bonds lose value. However, floating-rate loans just change the rate and their value stays the same.
Deposits fleeing causes banks to sell their loans so they can raise cash. If you are selling loans that have lost value, it has the same accounting impact as making bad loans that don’t get repaid. So banks that paid depositors by selling fixed-rate loans took large losses and were shut down.
This is not really a small vs. midsize vs. large dynamic. All banks have deposits and loans, but three banks who happened to be midsized had the wrong combination of deposits and loans.
The bank failures over the last six weeks were caused by a combination of 1) a lot of deposits withdrawing at the same time causing 2) the banks to sell bonds at a loss. To understand why some banks did or didn’t fail, you need to look at the makeup of deposits, and the types of loans they made.
Silicon Valley Bank and First Republic had a dangerously large share of uninsured deposits from tech startups. These are very similar companies, and they all started withdrawing money together. Almost all other banks (small, large, AND midsized) have a more diverse set of depositors, and many more deposits from retail clients like you and I that are insured by the FDIC.
SVB and First Republic took these deposits and made fixed-rate mortgage loans, and bought fixed rate bonds. While other banks (of all sizes!) have some of these assets, most banks make a lot of business loans and also issue credit cards. The key feature of these loans is that the interest rate changes (not 100% of the time, but it is extremely common). When interest rates go up, fixed rate bonds lose value. However, floating-rate loans just change the rate and their value stays the same.
Deposits fleeing causes banks to sell their loans so they can raise cash. If you are selling loans that have lost value, it has the same accounting impact as making bad loans that don’t get repaid. So banks that paid depositors by selling fixed-rate loans took large losses and were shut down.
This is not really a small vs. midsize vs. large dynamic. All banks have deposits and loans, but three banks who happened to be midsized had the wrong combination of deposits and loans.
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