If you’re trying to make sense of why Silicon Valley Bank and Signature Bank collapsed and what it means for your money deposited in a bank, you may find yourself opening Pandora’s box of complicated financial lingo.
If you’ve never heard of terms like systemic risk, bank contagion and more, you’re certainly not alone. Thankfully, bank collapses are relatively rare, which is why many of these terms aren’t commonplace.
But understanding some of these terms can go a long way in helping you unpack what’s been happening over the past week (You may even be able to impress your Tinder date too).
A bank run occurs when a majority of people who deposited their money at a given bank want to withdraw it at the same time. Because banks make loans using depositors’ money they don’t have all their money on hand.
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Even though banks are required to have a portion of depositors’ money set aside in cash reserves they cannot lend out, it’s not enough to guarantee that everyone can withdraw their money all at once.
Silicon Valley Bank and Signature Bank both experienced bank runs stemming from fears that the banks were on the verge of failing. Ultimately, when most depositors tried to pull out their money all at once, the Federal Deposit Insurance Corporation forced the banks to shut down.
When the FDIC took over SVB and Signature Bank it created new quasi-banks known as bridge banks.
The FDIC creates bridge banks when a bank fails so that it can transfer over any of its remaining assets and act on behalf of depositors to recoup as much of their money as possible. Like regular banks, bridge banks have their own boards of directors. But unlike regular banks, members of their boards of directors are appointed by the FDIC.
Bridge banks are also temporary and are designed to last until another bank buys it or all of its assets are liquidated, meaning they return to cash form.
Systemic risk exception
The FDIC, Treasury Department and Federal Reserve jointly announced that depositors at SVB and Signature would get all their money back even if it’s above the FDIC’s regular $250,000 insurance cap due to a “systemic risk exception”.
In the context of banking, a systemic risk occurs when one bank’s troubles or failure is feared to cause a domino effect across the entire banking industry. The government determined SVB and Signature’s failures, which would have left many uninsured depositors without immediate access to their money, posed a big enough risk to merit extraordinary actions.
Banks make profits by lending out some of the money they receive through deposits. However, regulations prevent them from lending out all of their deposits at a given time since that would mean customers wouldn’t be able to withdraw money.
One way to gauge the stability of a bank is to look at how much of depositors’ money they’re lending out. This is known as the loan-to-deposit ratio. The higher the ratio the more risky the bank is.
SVB loan-to-deposit ratio
The ratio isn’t a tell-all sign of how risky a position a bank is in. For instance, SVB’s ratio stood at 43%, according to the bank’s mid-quarter update. In mid-2022 the ratio was above 60% across the entire U.S. banking industry, according to S&P Global Market Intelligence data.
The ratio also doesn’t indicate if depositors’ money is being used in different ways besides making loans. In the case of SVB, the bank ran into trouble because too much of its depositors’ money was tied to investments made in U.S. bonds.
Elisabeth Buchwald is a personal finance and markets correspondent for USA TODAY. You can follow her on Twitter @BuchElisabeth and sign up for our Daily Money newsletter here