That’s exactly the scenario laid out by a new study released by Social Science Research Network (SSRN) last week.

The study found that 186 banks with a high level of uninsured debt or assets could be putting insured deposits at risk, and that these banks remain vulnerable to a run on deposits like SVB, SB, and Silvergate Bank.

While the US government insures bank deposits of up to US$250,000 (RM1.12 million), these at-risk banks have high numbers of uninsured depositors who the study claims are more likely to pull their funds for fear of losing them.

The banks also hold a significant amount of their assets in interest rate-sensitive financial instruments like government bonds, which are particularly vulnerable to interest rate hikes.

The study found that even if only half of uninsured depositors decide to withdraw, almost 190 banks are at a risk of impairment to insured depositors, with a potential US$300 billion (RM1.35 trillion) of insured deposits at risk.

It stated that the US banking system market value of assets is US$2 trillion (RM8.97 trillion) lower than suggested by their book value of assets.

The study noted that uninsured leverage (that is, uninsured debt or assets) is the key to understanding whether these losses would lead to some banks in the US becoming insolvent.

Using SVB as a case study, it found the bank had a disproportional share of uninsured funding: only 1% of banks had higher uninsured leverage. Combined, losses and uninsured leverage provide incentives for an SVB uninsured depositor run.

The study titled “Monetary Tightening and US Bank Fragility in 2023: Mark-to-Market Losses and Uninsured Depositor Runs?” was co-authored by Erica Xuewei Jiang (University of Southern California), Gregor Matos (Northwestern University’s Kellog School of Management), Tomasz Piskorski (Columbia Business School) and Amit Seru (Stanford University).

Why do banks fail?

A recent report on the US banking crisis by AHAM Asset Management stated there are over 4,700 banks operating in the US banking sector.

Between 2008 and 2012, 465 banks failed with total assets worth US$700 billion (RM3.14 trillion). And between 2018 and 2021, eight banks collapsed with total assets of US$672 billion or RM3.01 trillion (against SVB’s US$200 billion or RM897 billion).

So, why are so many banks in the US currently in danger of failing, just like SVB and SB?

The SSRN study explains that when central banks tighten monetary policy – like what the US Federal Reserve has been doing – it can have significant negative impacts on the value of long-term assets, including government bonds and mortgages.

This can create losses for banks which invest in and finance long maturity assets with short-term liabilities – deposits.

As interest rates rise, the value of a bank’s assets can decline, potentially leading to bank failure through two channels.

“First, if a bank’s liabilities exceed the value of its assets, it may become insolvent. Second, uninsured depositors may become concerned about potential losses and withdraw their funds, causing a run on the bank,” the report said.

Uninsured depositors represent a significant source of funding for US commercial banks, accounting for about US$9 trillion (RM40.37 trillion) of their liabilities, which can make runs a significant risk for these institutions.

What is starting to happen now has happened before – the SVB and SB collapse may just be the initial trickle before the deluge.

“In fact, during the 1980s and 1990s, nearly one-third of savings and loan institutions failed due to losses incurred from long-term fixed-rate mortgages that declined in value when interest rates surged,” the report added.

That is truly frightening.

Although the Biden administration had guaranteed all deposits for SVB and SB, US treasury secretary Janet Yellen stated last week that government refunds of uninsured deposits will not be extended to every bank that fails – only to those that pose systemic risk to the financial system.

Contagion likely to continue

Sunway University Business School economics professor Yeah Kim Leng told FMT Business the banking crisis in the US is far from over.

He expects the contagion to continue affecting sentiments, resulting in some of the weaker banks requiring some form of support from both the US government or bigger banks.

“Because of the contagion, systemic risk is involved, and although the government’s early assurance to provide full deposit insurance was helpful, the problem affecting other banks remains unresolved,” Yeah said.

Until there is clarity on the direction of interest rates, he said, further hikes will “compound the problem” faced by regional banks potentially facing bank runs.

The problem faced by the weak banks will be further exacerbated as depositors start shifting their deposits to the stronger banks.

“We may be seeing more mergers and acquisitions by the bigger banks,” he added.

A broken financial system?

Center for Market Education CEO Carmelo Ferlito said the root of the US banking crisis can be traced to the financial world order that emerged in 1971 after US President Richard Nixon cancelled unilaterally the direct international convertibility of the US dollar to gold.

This marked the end of the monetary system that emerged after World War II with the Bretton Woods agreement in 1944. Under the Bretton Woods system, gold was the basis for the US dollar and other currencies were pegged to the value of the US dollar, which became the world’s reserve currency.

“Nobody should be surprised by news (of the banking crisis) as with the end of the link between the dollar and gold, an extremely fragile monetary system emerged,” Ferlito said.

He said the world’s banking system now runs on a fractional reserve system where the financial equilibrium is based on the fact that people will not withdraw their deposits.

Under the system, only a fraction of bank deposits are required to be available for withdrawal, and banks only need to keep a specific amount of cash on hand and can create loans from the money that the people deposit.

Nevertheless, Ferlito opined that a massive withdrawal is unlikely unless panic really spreads, which did not even happen in the 2008-09 great financial crisis.