Is the World on the Brink of a Banking Crisis?

After a prominent U.S. bank collapsed last week, the public is growing increasingly worried about the health of the banking system. Is this an isolated incident, or is it the first sign of a much larger problem?

Banking crises have a tendency to spread once they begin, such as in the savings and loan crisis of the early 1990s.

What Happened to Silicon Valley Bank

The bank in question, Silicon Valley Bank (SVB), primarily provided loans to technology startups. By some estimates, SVB provided banking services for half of the country's tech startups that are backed by venture capital. These are companies that are in their infancy and typically don't generate a profit yet. In good economic times, incubating startups can pay off handsomely. During economic troubles, they are often some of the first enterprises to go belly-up.

A classic "run on the bank"—when too many customers withdraw their funds all at once—is ultimately what doomed SVB. Venture capitalists, which provided SVB with most of its funding, tend to be a closely-knit group. When one major investor sounded the alarm to pull their money out of the bank, the rest of the VCs followed. On Thursday alone, Silicon Valley Bank customers attempted to collectively withdrawal $42 billion.

The Federal Deposit Insurance Corporation (FDIC) stepped in to help, but FDIC insurance only covers up to $250,000 per account. Most of SVB's corporate customers had much larger deposits, so they are essentially only receiving pennies on the dollar.

Even as federal regulators and larger banks step in to try and stop the bleeding, retail customers at these banks also have cause for concern. Even if someone has nowhere near $250,000 in bank deposits, many big employers do. If a banking crisis spirals into an outright economic crisis for big companies, nobody would be insulated from the damage.

In total, the insolvency of SVB effects a staggering $209 billion in deposits. That makes it the second-biggest bank failure on record behind Washington Mutual in 2008. However, this is hardly the only worrying sign that's occurred recently in the banking sector.

More Bank Failures Looming

The Financial Times initially threw cold water on the idea that the failure of SVB would be the proverbial "canary in the coal mine" that alerts the public to a wider problem. Nonetheless, it's already clear that the collapse of Silicon Valley Bank is probably not an isolated incident.

Already, a second major bank in New York, Signature Bank, collapsed only days later. Its assets have been seized by regulators in what is now the third-largest bank failure ever in terms of deposits.

Several other big banks appear to be on the brink of insolvency, as well. For weeks there have been concerns about the industry behemoth Credit Suisse, one of the largest (and oldest) banks in Europe. Its stock price continues to fall to all-time lows. Credit default swap spreads, which reflect market expectations about a company defaulting, also continue to hit all-time highs for Credit Suisse.

Most major commercial banks like Credit Suisse are deemed "Too Big To Fail" (TBTF) by regulators.

It doesn't end there. Another bank called Western Alliance has seen share prices tumble by 85% in the aftermath of the SVB news. First Republic, another bank of considerable size, only saw its stock price rebound after an even bigger institution, JPMorgan Chase, stepped in to bail out the embattled firm.

Perhaps unsurprisingly, as depositors have fled with their money from several of these failing banks, the money has flowed into so-called "TBTF banks" like JPMorgan. That is unfortunately only the first set of reactions to the financial system's apparent fragility.

Knock-On Effects of Banking Troubles

There have been nearly 600 bank failures in the past two decades, a somewhat shockingly high number. Obviously a large portion of that came during the 2008 financial crisis.

The key point is that there tends to be a domino effect during banking crises. This is precisely what happened during the Great Depression and the Savings & Loan Crisis. Today, the financial system is even more interconnected and interdependent than ever before. The chances of a contagion spreading throughout the banking system is a chilling possibility.

Short-term difficulties for large banks have a bad habit of turning into insolvency.

Other economic effects are almost sure to make the situation even worse. The U.S. dollar fell sharply against its peer currencies in the aftermath of Silicon Valley Bank's collapse. Bond yields plunged as investors rushed for safer assets. Banks globally may face losses on depreciated assets, including banks in Europe. Even at the margins, the instability in the cryptocurrency market has also impacted banks, as we saw with the collapse of Silvergate Bank a few weeks ago.

The U.S. economy is also experiencing its first major contraction of the money supply in several generations. A shrinking M2 money supply is generally associated with major recessions, meaning that liquidity problems at banks may morph into more serious solvency problems.

Protect Yourself With Gold and Silver

The reasons for the impending banking collapse are not the same as they were in 2007–2008. Still, the risks this situation poses to broader markets are largely the same. While the Great Financial Crisis was almost 15 years ago, it should still be fresh in the minds of the general public now that similar events are unfolding.

Government institutions are likely to step in and bail out big banks. But as we saw in 2008, they are very unlikely to come to the rescue for the average person. Having a backup plan is essential.

Precious metals offer a safe alternative for storing your wealth outside of the banking system. We've seen that even the bond market is susceptible to strain and stress in the event of a crisis. Meanwhile, safe-haven demand for gold and silver usually causes their value to increase dramatically.

Gold and silver prices may fluctuate, of course, but they will never become worthless. Your metals will never vanish from a bank account or bond portfolio. Owning physical precious metals is the best way to ensure your financial well-being in the event these bank failures cause a larger financial calamity.

Gold bars and silver bars are popular physical bullion products for investors.

Learn more about issues facing the banking system with podcast episodes from Gainesville Coins:

Asset Bubbles and Financial Manias

Panic Grips the Repo Market! An Explainer

Collaterlized Loan Obligations (CLOs): Another Ticking Time Bomb?

The Rise of Financialization