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How Interest rate hikes affect U.S Bank Liquidity

 john Kreativ |
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Recent bank failures in the United States -U.S involing Silvergate Bank, Signature Bank and Silicon valley Bank have led most individuals to wonder if the country is headed for a recession. How did these bank failures happen? could it be as a result of interest rate hikes by the Fed or pure mismanagement that led to the collapse of these banks?

The collapse of silicon valley bank and Signature bank makes them the second and third largest in terms of total deposit and second and fourth largest in terms of total assets respectively after Washington Mutual Bank that collapsed in 2008 in US history.

Quick Overview

What caused U.S bank failure in 2023?

Three (3) U.S banks named in the post, experienced a bank run. A Bank run occurs when a large number of customers of a bank or financial institution withdraw their deposits at the same time over fears about the bank's solvency.

As more people withdraw their funds, the probability of default increases, which, in turn, can cause more people to withdraw their deposits. As the phenomenon increases, the bank's deposit reserves may not be sufficient to cover the withdrawals of customers, the reason being that customer deposits are loaned out to businesses and individuals and also invested.

The Federal Reserve or Fed is responsible for managing monetary policy and regulating the financial system in the U.S economy. In the lead-up period, many banks within the United States had invested their deposit reserves in U.S. Treasury securities, which had been paying low interest rates for several years.

As the Federal Reserve began raising interest rates in 2022, bond prices declined, decreasing the market value of bank capital reserves; causing some banks to incur unrealized losses to maintain bank liquidity.


In March 2023, the Federal Reserve announced another 25 basis point interest rate hike on Wednesday, making the benchmark rate the highest it’s been since 2007. The rate hike is meant to discourage inflation by increasing the cost of borrowing, which can slow the economy and possibly trigger a recession.

Silvergate Bank and Signature Bank, both with significant exposure to cryptocurrency, failed in the midst of turbulence in that market.

Silicon Valley Bank failed when a bank run was triggered, the Bank had to sell its Treasury bond portfolio in longer-maturity bonds at a large loss to meet customer demands, causing depositor concerns about the bank's liquidity. The bank's clientele was primarily technology companies and wealthy individuals holding having huge domiciled deposits.

How interest rate hikes affect U.S on economy

The fed funds rate or interest rate impacts how much commercial banks in general charge each other for short-term loans and also influences borrowing costs for consumers. A higher rate means it becomes more expensive borrowing money or accessing credit, which can reduce demand among banks, other financial institutions and consumers to access credit.

Increasing interest rates is also done in response to inflation. Inflation is experienced when there is too much money in circulation, more money chasing fewer goods, thus when there is aggregate demand for goods and services exceeding supply of goods and services, this causes prices to increase, to restore stability, the Fed increases interest rate to mob-up excess liquidity, thereby reducing inflation. One of the effective monetary policy tool that is used by nations.

How Interest rate hikes affect Bank liquidity

Central bank is responsible for formulating monetary policy to stabilize the value of the currency within and outside Ghana and to ensure the smooth operation of a safe and sound banking system. Central banks have the ability to increase interest rates, with an increase in interest rates, customers and businesses who have resources benefit, while individuals who want to access credit suffer through high interest rate charges.

A rise in interest rates increases profitability in the banking system. It is also an expansionary measure or a signal of a booming economy. Banks in line with their charter keep only a reserve out of the total deposit received from customers who want to save or use it for day to day requirements. The excess deposit is invested in short term, long-term profitable investments and loans for individuals and businesses who want to access credit. The yields or interest on these investments are set in excess of the amount paid on customer deposits, the difference will be realized as profit for the banks.

Banks experience financial distress or suffer a run when the deposits kept as reserve (liabilities) are not enough to meet customer demands. Banks will have to liquidate their investments (assets) at considerable cost in order to meet the demand. Assets redeemed before maturity loose value. The other assets given out as loans have underlying contracts can not be demanded prior to the date. Most loans also go bad and banks are required to write off such loans from their books at considerable cost. This phenomenon of is referred to as asset-liability mismatch or maturity mismatches. When maturity of liabilities is not matched with maturity of assets.

Is my money Insured and safe in U.S Banks?

In the U.S, deposits up to $250,000 in banks are insured by the U.S Federal Deposit Insurance Corporation (FDIC). If your deposit is less than $250,000 in an account at a US bank, then you almost certainly have nothing to worry about. Joint accounts are insured up to $500,000.
FDIC has greatly reduced the impact of bank runs for depositors with funds less than $250,000.



Reference:
https://www.investopedia.com/ask/answers/041015/how-do-interest-rate-changes-affect-profitability-banking-sector.asp

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