Silicon Valley Bank and the Changing Structure of Banking

From Jonathan Parker

Starting in March 2023, the U.S. banking sector experienced the failure of several major banks, and the entire industry was threatened with a crisis. Rising interest rates over the previous two years had diminished the value of banks' assets, as they typically borrow short term and lend or invest long term at fixed rates. But most banks have stable funding from deposits on which they have historically been able to pay low rates even when market interest rates rise, so that the losses in asset value are typically offset by increased future earnings. The banks that failed did not have these hedges because, in different combinations, their depositors were uninsured, exposed to increases in interest rates, or not “sleepy.” While policy responses have stabilized the banking sector for 2023, more banks may face similar challenges in the future as fintech and financial innovation continues to erode banking market power both in deposits – making the cost of funding more responsive to market interest rates – and in lending – reducing the role of long-term relationships between banks and borrowers and so reducing the stability of funding, but also the importance of banks in the U.S. economy.