Over the weekend, US financial regulators averted panic after another bank collapsed. First Republic Bank became the latest US bank to default in recent months after customers withdrew about $100 billion in deposits, causing its shares to plummet — from $122.50 on the day March 1 to $12.18 on March 20. With that, the US seems to have put its banking woes behind it for the time being, as most small banks have reported respectable returns for the last quarter.
Over the weekend, US financial regulators averted a panic after another bank collapsed. First Republic Bank became the latest US bank to default in recent months after customers withdrew about $100 billion in deposits, causing its shares to plummet — from $122.50 on the day March 1 to $12.18 on March 20. With that, the US seems to have put its banking woes behind it for the time being, as most small banks have reported respectable returns for the last quarter.
The California Department of Financial Protection and Innovation took over the ailing bank and placed it under the receivership of the Federal Deposit Insurance Corporation (FDIC). The FDIC solicited bids for the California-based lender, and regional banks — including PNC Financial Services Group Inc, Citizens Financial Group Inc, and Fifth Third Bancorp — submitted bids.
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The California Department of Financial Protection and Innovation took over the ailing bank and placed it under the receivership of the Federal Deposit Insurance Corporation (FDIC). The FDIC solicited bids for the California-based lender, and regional banks — including PNC Financial Services Group Inc, Citizens Financial Group Inc, and Fifth Third Bancorp — submitted bids.
In the end, the FDIC chose the bid from JPMorgan Chase, America’s largest lender, because it offered the lowest cost to the regulator. Once JPMorgan acquires all of First Republic’s deposits and most of its assets, the FDIC will incur a loss of approximately $13 billion and make a $50 billion loan to JPMorgan to bridge the acquisition.
Banks in the US, like most places, don’t have the same bankruptcy procedures as non-financial corporations. Regulators are stepping in to protect the financial system from systemic damage. Silvergate Bank voluntarily shut down in March, prompted by its huge exposure to the cryptocurrency ecosystem and the collapse of crypto exchange FTX.
Silicon Valley Bank and Signature Bank failed in rapid succession, largely because they failed to update the maturity profiles of their assets and deposits while the Fed hiked interest rates at a record pace. The long-term government bonds, in which the banks had invested part of their deposits, fell in value as interest rates rose. When depositors panicked following Silvergate’s self-liquidation and began moving money from smaller banks to larger ones, the banks were able to pay depositors who were reclaiming their money by selling these written-off assets.
The Trump presidency watered down the regulatory and supervisory norms for smaller US banks, which allowed those banks’ problems to worsen. These dormant problems were triggered when interest rates rose sharply over the course of a year.
What is striking in the resolution of First Republic Bank’s failure is the attempt by US banking regulators to let market forces work in the resolution process. Regulators took over the bank when its collapse seemed imminent but sold it after writing down its equity and debt to zero and then solicited bids for the bankrupt company. The FDIC had to absorb some of the losses on the bank’s assets and chose the offer that would minimize those losses.
This is in contrast to what the Reserve Bank of India (RBI) did, for example, in the case of Yes Bank and Laxmi Vilas Bank, both of which were restructured and placed under new management at the discretion of the regulator (LVB was sold to the Indian subsidiary of Singapore-based DBS) and not through a formal, market-based process. Swiss authorities also prompted UBS to take over troubled Credit Suisse through its privileged access to bank management rather than through a market-based process.
The bottom line is that regardless of the intervention model, further contagion was averted and minimal disruption was created for those involved. Of course, Yes Bank’s Additional Tier 1 (AT1) bondholders are upset because their bonds have been written off while stocks have not.
The truth is that AT1 bondholders’ grouse is based on confusing terminology. AT1 bonds are bonds in name only. They are a kind of insurance against the collapse of a bank that is supposed to be written off before it gets into serious trouble. They are similar to catastrophe bonds, which reinsurers issue to provide a pool of payments if a catastrophe against which insurance was sold does occur.
Investors know that the only reason they get a better return on these bonds is because they risk being written off, in whole or in part, in the event of a catastrophe. Credit Suisse’s Additional Tier 1 bonds were also written off in full before being sold to UBS, while preserving their equity, albeit at a fraction of their previous value.
Uday Kotak praised the manner in which JPMorgan took over First Republic Bank and urged India to have domestic banks so well funded to play a similar role in crises. Fair enough. India is compensating for lack of depth in financial markets with regulatory activism. But deepening financial markets is the only way to ensure there are market-based solutions to financial problems.
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