In March 2023, several major regional banks suddenly and dramatically failed. An important question for investors is: is there more to come?

In this post, we argue that based on history, there is more banking industry stress coming.

Before we get to that argument, let’s look at the market for bank stocks since March.

This index includes all the big US banks, and represents most of the market capitalization of the US banking system.

When Silicon Valley Bank and several other regional banks failed in March, as the chart shows, the market decided that the banking industry as a whole was suddenly now worth much less.[1]

Should we be worried that (according to the index) the market believes the banking system is still about as stressed as it was just after the crisis was, seemingly, averted?

One way to answer the question is to turn to history.

A study a few years ago, the CFA Institute[2] found that 96% of the financial professionals surveyed believed that knowledge of economic and financial history was important to their professional success.

So, we’ll present some history relevant to the recent banking crisis.

The March Banking Crisis in Context

A recent paper by Yale’s Andrew Metrick with Paul Schmelzing[3] puts the current banking crisis in context by looking at “over 2000” government interventions in the banking system (who knew there were that many?) over the last 750 years. Most of these interventions occurred since 1870. The first intervention they report occurred in November of 1299 in the city of Barcelona. Barcelona was then an important banking center. When a key lender went bankrupt, city officials guaranteed the depositors of several banks.[4]

The March Crisis

Metrick and Schmelzing categorized these 540 events by the types of interventions made in each. They identified seven major categories of interventions, which are:

• Asset management
• Guarantees
• Lending
• Rules
• Restructuring
• Capital Injections
• Other

Focusing on the Silicon Valley Bank specifically, Metrick and Schmelzing look at the interventions by US authorities, as well as by the Germans, because Silicon Valley Bank had a German subsidiary with almost a billion euros in assets.

In the US, the Fed (interestingly, not the FDIC, which nominally in the US is the “protection” for depositors) created an emergency lending facility. Metrick and Schmelzing consider this to be an intervention of the “Lending” category.

In the aftermath of the Silicon Valley Bank collapse, the FDIC announced that it would extend its “insurance” coverage to most of the deposits at Silicon Valley Bank that were not covered by its previously-stated $250,000 limit. Of course, the FDIC relies on the US taxpayer to make up any shortfall between money demanded by depositors and money in the FDIC’s existing account, otherwise its promise would be empty. Metrick and Schmelzing categorized this FDIC intervention as belonging in the “Guarantees” category.

Shortly after the above actions, the US Treasury announced that it had assembled a group of eleven banks that collectively would deposit $30 billion into First Republic Bank, which had also experienced a bank run. Metrick and Schmelzing categorized this action as part of the “Capital Injections” category.

Metrick and Schmelzing Database

Metrick and Schmelzing reviewed their database of interventions and found 57 previous episodes that were characterized primarily by a combination of account guarantees and emergency lending. They note that as they have 2000 or so interventions, this particular combination is “relatively rare.” Prior examples include: Argentina 1980, Denmark 1907, France 1848, Indonesia 1992, Norway 1987, and Ireland 2008.

Were these 57 Crises “Systemic”?

Regarding the March 2023 crisis, we are interested in what history can tell us about the probability that the crisis may not be over.

The past is not a guarantee of the future, but it may help us make an educated guess.

Of the 57 similar crises in their database, Metrick and Schmelzing find that 45, or almost 80%, of the crises were considered “systemic.” This 80% is much higher than the overall approximately 50% of cases that were considered “systemic” crises.

They conclude,

The March 2023 pattern of interventions strongly suggests we are

already in the midst of a systemic event.[5]

Neither Metrick and Schmelzing, nor us, can say for certain whether, or when, the banking crisis will re-emerge. Or if it does, what its effect on markets will be.

However, one thing seems clear: if the crisis does re-emerge, it will probably be bad for stocks, and banking stocks in particular.

Action to Take

If you have clients with outsize positions in a stock, as you know, even in normal times such a position represents excess risk. That is, if it weren’t for the tax consequences of taking a large gain, clients should in general manage the excess risk by diversifying.

We want to remind you of the potential use of a Stock Diversification Trust as a tax-efficient way for a client to diversify a concentrated stock position with large unrealized gains. To learn more, ask us for a free copy of our Advisor Guide to Concentrated Stock Holdings, or call us at (703) 437-9720 and ask for Katherine or Connor, or email Connor at [email protected].

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[1] JP Morgan has been an exception. It is possible that the market believes that Morgan will be a net beneficiary of government guarantees and the ability to consolidate its already leading position as the “biggest bank in the world.”

[2] https://blogs.cfainstitute.org/investor/2015/07/23/financial-history-how-to-learn-from-it/

[3] The March 2023 Bank Interventions in Long-Run Context – Silicon Valley Bank and beyond

Andrew Metrick and Paul Schmelzing, NBER Working Paper No. 31066     

[4] La Primera Crisis Bancaria De Barcelona, Stephen P Bensch, Anuario De Estudios Medievales. Volume 19, 311-328

[5] Emphasis added