Bankruptcies and bank failures such as Silvergate, SVB and Signature Banks, and the impact of digital money (Part 1)

The present economic environment is witnessing a notable increase in bankruptcies, indicative of a wider financial instability. With traditional government debt at all-time highs in many jurisdictions, simply printing more money (putting financial structures under mounting pressure) may well not be an option this time and, resultant from this, means there is a rising focus on digital currency and its potential to transform the financial landscape. In the US, bankruptcy filings surged by 16% for the year ending March 31, 2024 - reaching 467,774 cases - with business bankruptcies rising sharply by 40.4%. This trend was exacerbated further by the tightening of US monetary policy back in 2023 which contributed to the collapse of Silicon Valley Bank in a mere 48 hours due to a run on deposit amid rising interest rates. Banks with heavy investments in long-term assets such as mortgage-backed securities and Treasury bonds saw significant declines in asset values. In February 2024, company insolvencies in England and Wales rose by 17% (surpassing pre-pandemic levels) with increases in voluntary liquidations and administrations. Individual insolvencies across the UK, totalling 10,136, rose by 23%, driven by bankruptcies, debt relief orders and voluntary arrangements. Scotland reported a 9% increase in company insolvencies (primarily in voluntary liquidations) whilst Northern Ireland saw a doubling of company insolvencies, reflecting heightened economic stress.

The year 2023 certainly proved historic for the US banking sector with a notable surge in bank failures, marking it as the most significant year for such collapses. SVB's sudden demise in March, followed by Signature Bank's and First Republic Bank's failures, underscored severe liquidity challenges amid rising interest rates. These failures collectively accounted for $548.7 billion in assets, surpassing even the 2008 financial crisis. Adding to the distress, the collapse of crypto-friendly Silvergate Bank and Heartland Tri-State Bank exposed vulnerabilities in sectors heavily exposed to market volatility and fraud risks. The Federal Deposit Insurance Corporation (FDIC) estimated losses of $16.3 billion to its Deposit Insurance Fund due to these failures, prompting calls for stricter regulatory measures and higher capital requirements to fortify financial stability in the banking industry. Similarly on this side of the pond, bankruptcy rates have surged in Europe with severe economic challenges reflected in Sweden and Germany. In Sweden, bankruptcies rose sharply by 29% in 2023, reaching the highest levels since the 1990s; this upward trend persisted despite recent monetary policy adjustments aimed at stabilising the situation. In December alone, bankruptcies in Sweden accelerated by 23% year-over-year, reversing a brief period of stabilisation seen earlier on in the year. Significantly, this downturn is anticipated to push Sweden into a recession despite efforts by the Riksbank to curb prolonged interest rate hikes. Notably, bankruptcies in the wholesale sector jumped by 72% in September from a year earlier, underscoring the widespread economic impact. Meanwhile, Germany has recently experienced a substantial rise in corporate bankruptcies. According to the Federal Statistical Office, insolvencies surged by 26.5% in the first quarter of this year compared to the same period last year and projections suggest that the total number of insolvencies might approach 20,000 by the end of 2024. Economic challenges from the COVID-19 pandemic, along with escalating energy costs and increasing interest rates, are putting significant pressure on businesses in various sectors including manufacturing and services.

Moreover in Asia, corporate bankruptcies in Japan and China reflect significant economic challenges. In Japan, bankruptcies reached a nine-year high, with more than 9,000 cases recorded in fiscal 2023. This surge, a 32% increase from the previous year, was largely due to the end of pandemic-era government support, such as zero-interest loans. Sectors including construction and wholesaling experienced substantial increases in bankruptcies, with 39% and 27% rises respectively. Small and midsize enterprises, struggling with cost inflation and labour shortages, were particularly hard hit, and regional disparities were evident, with Shikoku experiencing a 57% increase in bankruptcies. Analysts predict that bankruptcies could exceed 10,000 in the current fiscal year as the economy transitions back to a normal cycle of business failures and start-ups. Likewise, China has experienced a notable debt burden evidenced by a debt-to-GDP ratio of 288% in 2023. The housing sector has suffered significantly, with sales dropping by one-third and new construction activity falling 60% from its pre-pandemic highs - this economic contraction parallels Japan's stagnation following 1989. Furthermore, China’s “Three Red Lines” policy has tightened credit for heavily indebted property developers, leading to numerous bankruptcies and a decrease in property prices. This suggests that China's economic woes will continue, impacting the global economy extensively.

So, what lessons can we draw from the Silvergate, SVB and Signature Bank collapses? In early March 2023, banking was jolted by Silvergate's announcement to cease operations after selling additional debt securities. Shortly after, on March 10, 2023, Silicon Valley Bank (SVB) was taken over by the California Department of Financial Protection and Innovation due to significant investment losses and a surge in depositor withdrawals. Following this, on March 12, 2023, federal regulators shut down Signature Bank, prompted by fears of widespread withdrawals in the wake of SVB's collapse. The failure of Silicon Valley Bank (SVB) on March 10, 2023, marked a significant event in the financial industry. With approximately $209 billion in assets and a non-performing loan ratio of 0.24%, SVB played a critical role in the tech sector, providing financing to nearly half of all US venture-backed technology and healthcare firms. The bank’s collapse was caused by a lack of diversification and a traditional bank run, i.e., depositors asking for their money back (accelerated by the ability to request withdrawals on-line). SVB’s heavy investments in long-term US treasuries and mortgage-backed securities left it exposed when the Federal Reserve increased interest rates in 2022. The drop in bond values eroded SVB’s capital, causing the bank to struggle to sell long-term investments to pay its depositors without incurring significant losses and ultimately leading to its demise. Signature Bank, which failed on March 12, 2023 with approximately $110 billion in assets and a non-performing loan ratio of 0.72%, fell prey to the panic triggered by SVB's collapse and its high exposure to uninsured deposit and the tech sector. Regulators shut down Signature Bank in order to prevent further contagion in the banking sector, irrefutably highlighting the systemic risks posed by concentrated exposures to the tech and start-up businesses. The loss of the Silvergate Exchange Network (SEN) and Signature’s Signet has also been a huge and fatal blow. SEN and Signet allowed crypto clients to make real-time payments and it could take a while to gain back to regain their losses which will potentially impede the mass adoption of crypto.

But the three banks were more than simply acting as the ‘go-to’ banks for tech, crypto start-ups, VCs and FinTechs - they were also integral to the relationship between the banking world and crypto. Yet, despite SVB’s seizure, the UK unit (acquired by HSBC for $1.20) did not experience the same level of disruption. This prompts speculation about whether UK crypto regulations differ from US regulations or if the majority of the UK SVB clients were non-crypto. Unsurprisingly, government and regulatory responses to these failures have been marked by heightened scrutiny and caution. Some, such as former congressman, Barney Frank, have suggested that the federal government’s actions against banks with significant crypto exposure were intended to send an anti-crypto message. Furthermore, lawmaker, Tom Emmer, has echoed concerns that the government is using banking issues as a pretext to target the crypto sector. Reports suggest that the FDIC imposed conditions requiring bidders for Signature Bank to divest its crypto business, reflecting broader regulatory apprehensions. As of March 11, 2024, investors are increasingly anxious as the Federal Reserve ends the Bank Term Funding Program (BTFP), a key support mechanism introduced in response to the failures of Signature, Silvergate and Silicon Valley Banks. This program allowed banks to borrow from the Fed using their bonds as collateral, alleviating the pressure from bond value declines due to rising interest rates. And with the BTFP’s closure, banks will no longer benefit from this emergency support. So, whilst banks can still access funding through the discount window, the end of the BTFP could increase borrowing costs and reduce profit margins potentially leading to higher lending rates or less credit availability which could weaken the economy further.

Another issue to consider is the effect of quantitative tightening (QT), which started in 2022 and entails central banks selling off bonds and removing the proceeds from the financial system. The overnight reverse repo facility has somewhat softened the impact of QT, allowing banks to park excess cash with the central bank in exchange for government bonds. Yet despite a significant drop in usage from over $2.2 trillion in mid-2023 to under $600 billion by January 2024, this facility still helps to mitigate the effects of QT. Furthermore, the Federal Reserve has signalled that it will decelerate and eventually halt QT (though this transition may be challenging) potentially leading banks to increase lending rates and reduce their willingness to lend. Amid these shifts, banks face ongoing challenges - heightened interest rates have led to the most stringent credit standards and weakest loan demand in years. Additionally, the commercial real estate (CRE) sector remains a source of vulnerability, particularly for regional banks that have a higher exposure to CRE loans. Small banks hold 4.4 times more exposure to US CRE loans than their larger counterparts, with these loans making up almost 30% of their assets. In particular, the office sector faces challenges due to the rise of hybrid work and whilst delinquencies have been minimal, the need for refinancing at higher rates poses risks.

Essentially, the rise in global bankruptcies (particularly in the banking sector) underscores the fragile nature of current economic conditions. The collapse of major banks such as Silvergate, SVB and Signature Bank in the US has undeniably highlighted the systemic vulnerabilities within the financial industry and has led to significant financial losses and regulatory scrutiny as a result. The failures of banks in various jurisdictions and how secure banks are pose significant questions as to the surety of relying on fractional banking and what role could digital money platforms backed by cash deposits play. Undoubtedly, the programmability of digital is very attractive. JP Morgan believes that “programmability in payments encompasses automating, customising and executing financial transactions via software and code.” And new opportunities and efficiencies in payments and banking can be unlocked - not currently possible with client-side programmability on traditional banking platforms. But, more on this in Part 2 of ‘Bankruptcies and bank failures such as Silvergate, SVB and Signature Banks, and the impact of digital money.’ 

 This article first appeared in Digital Bytes (28th of August, 2024), a weekly newsletter by Jonny Fry of Team Blockchain.