US Government tries to prevent bank failure contagion from spreading

15 Mar 2023 , 02:21 PM

US Government institutions, the US treasury, Federal Deposit Insurance Corporation and the Federal Reserve are trying to prevent the bank failure crisis from spreading to other banks. They are doing so by allowing the depositors of Silicon Valley Bank and Signature Bank to withdraw their full money instead of just $250,000. In case of bank failures, US Federal Deposit Insurance Corporation insures only a maximum of $250,000 of the deposited amount. This means that if a customer’s account has more than $250,000, then there is no guarantee that the customer will get back the money above $250,000 in case the bank fails. 

The bonds and loans of SVB and Signature will be sold to raise money to ensure that depositors of the two banks are able to withdraw all their money. Any shortfall that remains after the sale of these assets will be paid by US Federal Deposit Insurance Corporation. So effectively the US Government has guaranteed the full amount of the depositors of the two banks. This has been done to prevent a run on other banks by assuring their customers that their entire money is safe. 

A run on a bank means customers suddenly rushing to the bank in large numbers to withdraw their deposits because of the fear that the bank will fail and will not be able to return their deposits in the near future. Such a run happened on SVB on March 10^th. This triggered the current banking crisis.

As an additional measure to prevent the crisis from spreading further, US Federal Reserve has set up a new lending facility for banks. Banks can do emergency borrowing from the US central bank under this facility, if they face any liquidity crisis. They can pledge securities that they hold, such as bonds, and get money equal to the face value of these securities as loan. The interest rate that they will have to pay on this borrowing will be just 0.1% above the one-year overnight index swap rate. This rate roughly equals the Federal Funds rate.