The abrupt collapse of Silicon Valley Bank (SVB) has sent seismic waves through the placid waters of American banking, eliciting deep-rooted tremors that could unsettle the entire financial sectorThis event was not a standalone incident but rather the catalyst that unceremoniously pried open Pandora's box, exposing long-buried issues within the banking system.

The unfolding crisis unveils a stark reality: the problems affecting SVB are far from uniqueInstead, SVB is likely to serve as the first domino in a chain reaction that threatens to cascade through numerous banks in the U.S., unraveling the already fragile fabric of the financial landscape.

Statistics from the Federal Deposit Insurance Corporation (FDIC) highlight the breadth of the challenges facing American bankingOver the past year, the Federal Reserve's aggressive monetary policies have resulted in a staggering increase of 450 basis points in interest rates.

This rapid escalation has had dire implications for the securities held by American banks, with unrealized losses ballooning to an astounding $620 billion

Such a monumental figure looms over the banking sector like Damocles' sword, casting a shadow of existential dread over financial institutions.

The FDIC has expressed grave concerns about how these unrealized losses are severely diminishing the equity capital of the banking sectorFor instance, at one prominent bank, these floating losses have reached a disturbing 43% of its own equity capital.

Should the Federal Reserve maintain its course of increasing interest rates and engaging in balance sheet reduction, even major players like this bank might find themselves on a precarious path closely mirroring that of SVB.

Smaller banks are at an even greater risk, as their equity capital constitutes a minuscule fraction of their total assetsWhen interest rates rise dramatically and asset prices plummet, equity capital becomes the first casualty, putting banks in a dire position of insolvency.

Insolvency can trigger a severe credit crisis

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There are primarily two types of banking crises: a liquidity crisis, where banks lack sufficient reserves to meet withdrawal demands, and a credit crisis that emerges when a bank depletes its equity capital entirely.

Currently, both crises are simultaneously manifesting within the American banking sectorSuch a scenario was virtually unprecedented in the lead-up to 2022, leaving financial regulators such as the SEC blindsided by the potential for such upheaval.

In September 2022, SVB’s securities losses were minor; however, within mere months, these losses escalated dramatically, effectively eroding its capital base and catching stakeholders off guard.

The traditional financial environment cannot accommodate a rate increase of over 450 basis points within a single yearThe Federal Reserve’s aggressive rate hike policy of 2022 has acted as a bombshell, radically destabilizing the long-standing equilibrium of the American banking system.

The downfall of SVB serves as a harrowing reminder of the potential for wider repercussions

Should other banks experience a similar run on deposits, the ramifications could be catastrophic.

At present, the American banking sector faces unrealized losses that have escalated to $620 billion, resembling a volcano on the verge of eruption, threatening the wellbeing of the entire industry.

If just one bank falls prey to a run on deposits, it could trigger a cascading effect, causing the entire banking industry to plunge into an irretrievable crisisThis is precisely what has fueled the recent plummet of bank stocks in the market.

Concurrently, the concentration of withdrawal risks among American savers continues to riseSVB’s clientele primarily consisted of cash-burn startup companies that consistently withdrew funds from the bankWhile this case is somewhat isolated, the shifting market conditions now present similar risks across other banks as well.

Other institutions are facing analogous threats

Presently, the interest rates for order accounts provided by commercial banks languish at a meager percentage, barely above zero.

In stark contrast, the interest rates on six-month U.STreasury bonds hover near 5%. This glaring discrepancy is prompting savers to reassess their options.

Citizens interested in purchasing Treasury bonds can do so through specialized accounts set up in the Treasury DepartmentIn essence, this transition means that depositors are shifting their funds from banks to Treasury accounts, which fall under the purview of the Federal Reserve.

This functionality mirrors bank reserves being siphoned off to Treasury General Accounts (TGAs), equating to a liquidity squeeze that mimics the effects of a bank run.

As the interest rates on U.STreasury bonds continue to rise, more individuals are waking up to the realization that keeping their savings in banks may be less advantageous than investing in government bonds.

Once this trend solidifies, a significant shift in savings will be inevitable, putting many undercapitalized small and mid-sized banks in jeopardy, mirroring the predicaments faced by SVB.

If the Federal Reserve persists with its balance sheet reduction policies, it will only exacerbate the liquidity crises plaguing the banking system