By Ketki Saxena
Investing.com -- The recent rescue of two failed banks by the Biden administration and Federal Reserve sparked controversy, with allegations of encouraging risky behaviour by banks, reminiscent of the 2008 financial crisis
However, new data from economists at Stanford University, University of Southern California, Columbia University, and Northwestern University shows that the banks recently in turmoil were in fact too big to fail. Without a bailout, a run on deposits at these banks could have set off a cascading series of bank failures that would cripple small businesses and economic activity across wide parts of the country.
The study analyzed geographic risks from banking crises to reveal how vulnerable many counties are due to their reliance on relatively few financial institutions for deposits and loans. As interest rates increased to tame inflation, many banks' financial positions deteriorated as they held government bonds in their portfolios.
While Silicon Valley Bank was more exposed than most other banks to risks of rapid interest rate increases, hundreds of U.S. banks saw dangerous amounts of balance sheet deterioration over the past year as rates rapidly increased. To map vulnerabilities across the country, researchers calculated how much Fed interest rate increases reduced asset values compared to deposits for individual banks and estimated risk levels for every county in America.
While damage has been contained so far, larger runs on vulnerable banks could result in a significant drop in credit available to store owners, home borrowers, etc., effectively stifling access to credit for entire communities.
The researchers also warned regulators haven't permanently addressed vulnerabilities within our banking system leaving economically disadvantaged areas susceptible to shocks ranging from small-business lending pullbacks - which may already be underway -to depositor runs that cut off easy access nationwide.
Federal Reserve staff hinted at broader banking-related hits potentially skewing baseline risks toward downside effects in their March meetings released Wednesday.
As per the research, the potential damage from banking crises remains widespread even after recent rescues stabilized the threatened depositor-run banks. While smaller regional banks face new risks due to commercial real estate market downturns setting off another run on deposits; the new research warns the system is not yet fully insulated against future crises that could cripple small businesses and economic activity nationwide.