The banking industry is a cornerstone of the global economy, facilitating the flow of capital and supporting businesses and individuals with their financial needs. However, the industry is not immune to challenges, and bank failures can cause significant disruptions in financial markets. In recent times, there have been reports of bank failures and acquisitions, raising concerns about the stability of the banking industry.
Let us explore the recent bank failures, the reasons behind them, and the impact they may have on the banking industry and the wider economy. Although not widespread, there are many banks that have made poor decisions with how they have invested their funds. The deposits they receive from their bank customers are the funds being invested, and many banks have invested in longer-term investments, such as treasuries. In the past year, the Federal Reserve has aggressively raised rates, causing the value of the treasuries held by banks to reduce.
Which Bank Failures Happened This Week?
Citizens Bank, Sac City, Iowa, has made headlines this week as it was closed by the Iowa Division of Banking. In response to this, the Federal Deposit Insurance Corporation (FDIC) was appointed as the receiver. Let's delve into the details of this recent bank closure.
To safeguard the interests of depositors, the FDIC entered into a Purchase and Assumption Agreement with Iowa Trust & Savings Bank, Emmetsburg, Iowa. This agreement involves Iowa Trust & Savings Bank assuming all of the deposits previously held by Citizens Bank. Furthermore, the two branches of Citizens Bank will reopen as branches of Iowa Trust & Savings Bank, ensuring that customers can access their accounts seamlessly.
During the transition period, depositors of Citizens Bank can access their money through various means, including writing checks or using ATM and debit cards. Checks drawn on the bank will continue to be processed, and loan customers are encouraged to make their payments as usual.
One key piece of information for depositors is that they will automatically become depositors of Iowa Trust & Savings Bank. This means that customers do not need to change their banking relationship to maintain their deposit insurance coverage.
As of September 30, 2023, Citizens Bank had approximately $66 million in total assets and $59 million in total deposits. Additionally, Iowa Trust & Savings Bank has agreed to purchase essentially all of the failed bank's assets.
The FDIC estimates that the cost to the Deposit Insurance Fund (DIF) will be $14.8 million as a result of this bank closure. It's worth noting that this fund, established by Congress in 1933 and managed by the FDIC, is designed to protect the deposits at the nation's banks.
Citizens Bank's closure marks the fifth bank failure in the nation this year. Notably, the last bank failure in Iowa occurred on November 18, 2011, with the closure of Polk County Bank in Johnston, Iowa.
The closure of Citizens Bank and its subsequent acquisition by Iowa Trust & Savings Bank highlights the dynamic nature of the banking industry. Customers of Citizens Bank can expect a smooth transition without needing to change their banking relationship. The FDIC, through its diligent efforts, ensures the protection of depositors and the stability of the banking system. It's also a reminder of the vital role the Deposit Insurance Fund plays in safeguarding the nation's bank deposits.
Potential Reasons for the Banking Failures in 2023
Although not widespread, there are many banks that have made poor decisions with how they have invested their funds. The deposits they receive from their bank customers are the funds being invested, and many banks have invested in longer-term investments, such as treasuries. In the past year, the Federal Reserve has aggressively raised rates, causing the value of the treasuries held by banks to reduce.
Several reasons have been identified for the banking turmoil:
- Large Deposits: Many of the banks under pressure have a large number of deposits that are too big to be insured by the Federal Deposit Insurance Corporation (FDIC). This makes them vulnerable to a run, where customers scramble for their money back, and a bank would be unable to deal with that demand.
- Investments in Government Bonds: Investments made by investment banks in government bonds have lost value as the Federal Reserve has raised interest rates aggressively. This has led to a significant reduction in the value of these investments.
- Exposure to Commercial Mortgages: Many lenders are exposed to commercial mortgages, which are becoming increasingly risky as the economy slows down. These mortgages are often made to businesses that are unable to repay their loans in a timely manner, resulting in higher levels of defaults and foreclosures.
Duration Problem with Balance Sheet Assets
The bank can hold these securities to maturity and receive the invested funds back. The problem comes up if the bank is short on covering customer deposits and must sell these investments. In doing so, the bank may take significant losses on these investments. Therefore, banks have a duration problem with their balance sheet on how they hold assets.
Banks that have been better managing their assets will be in a solid position, which may be the case when it comes to smaller community banks. These banks may be more invested in their local communities, which may be more sustainable. However, unfounded fears have led bank customers to move their deposits to the few megabanks, believing that they are safer as they are too big to fail. This reaction could have some negative consequences in smaller communities.
Tightening Credit and Economic Slowdown
The bank failures also create additional credit-tightening consequences. As the Federal Reserve continues to tighten, they create more strain on the banking sector. Perhaps it may be time for the Fed to pause on its aggressive tightening with its rate increases as it is beginning to impact many segments of the economy.
This past Wednesday, the Fed increased its overnight lending rates by another .25%. With the latest bank failure, this may be a strong signal that the Fed should pause on any future increases. The cumulative effect of the rate hikes over the past year will continue to slow the economy, bringing the current inflation rate lower.
No Further Contagion Amongst Regional Banks
These bank failures have little in common with what happened in the 2008 housing crisis. With these recent bank events, the hope is that there is no further contagion amongst regional banks. Fed Chairman Jerome Powell did state that the banking sector remains strong. However, new signs of banking turmoil have emerged following the failure of First Republic Bank.
The third bank failure in 2023 has raised concerns about the stability of other regional banks. Shares of several regional banks, including California-based PacWest and Western Alliance, have been hit hard, fueling fears of more bank failures. The situation has been worsened by Wall Street investors who are betting on a further decline in regional bank shares.
The current situation in the banking industry is uncertain, and the future remains unclear. While some regional banks may struggle in the short term, others are expected to remain stable. Smaller community banks, in particular, may be better positioned to weather the storm, as they are more invested in their local communities and have a more personal relationship with their customers.
In conclusion, the banking industry is currently facing a period of turmoil, with several bank failures and increasing concerns about the stability of the industry. However, it is important to note that not all banks are created equal, and some may be better positioned to weather the storm than others. Additionally, there are steps that can be taken to improve the stability of the industry, such as reducing the reliance on large deposits and investing in less risky assets.