Trust is integral to the proper functioning of the banking system. Banks must manage and care for people’s money or property as fiduciaries. When a bank collapses, it destroys trust among its depositors. In the case of a series of bank failures, faith in the banking system erodes, often sending shockwaves across financial markets.
History has taught us that bank collapses happen repeatedly—two of the worst examples being the Great Depression and the financial crisis of 2008. They can happen unexpectedly and suddenly.
Trust-eroding events have wide-ranging implications across industries and institutions, not just in banking and finance. They impact small-to-medium business owners, hindering their ability to obtain credit and continue their activities. They also have a real effect on ordinary people’s lives regarding the potential loss of life savings and purchasing power.
The recent high-profile collapse of Silicon Valley Bank (SVB), followed by Signature Bank and First Republic Bank, exemplifies how such failures create volatility in markets and businesses, destroying consumer confidence in the banking system and resulting in panic and bank runs.
SVB was the 16th largest bank in the US and a key tech lender. Its failure was the largest since 2008, so it was immediately shut down and taken over by regulators. The US government, alongside the Federal Reserve and the FDIC, developed unprecedented backstop measures to prevent further contagion, stating that all depositors of failed bank SVB would be made whole. The backstop helped ease depositor panic. However, early-stage tech businesses, i.e., start-ups, felt the effect as funding began to dry up and tech layoffs became more prevalent.
Taking a lesson from history, businesses that keep their assets with banks must prepare for all disruptions and shocks. Here, we review banking crises’ impact on businesses and what companies of various sizes can do to protect themselves if bank failures occur.
Is it a 2008 Financial Crisis Deja Vu?
Many have compared the recent banking crisis to the early events of 2008. Others have gone further back to review the historical events of the Great Depression. Did we have the same weaknesses in the financial system then as we do now? There are fundamental similarities and several critical differences in what triggered the crises’ bank runs.
The 2008 financial crisis originated in the subprime mortgage crisis 2007, which entered a speculative bubble fueled by risky lending practices. Financial institutions granted mortgages to borrowers with poor creditworthiness. The resultant wave of defaults plunged the value of mortgage-backed securities (MBS).
The subsequent collapse of subprime lending fueled a downward spiral in home prices, unwinding the gains of the subprime boom. This collapse was the impetus for the 2007-2009 recession, which hurt the US economy in four ways: wealth reduction and the resultant drop in consumer spending, lowered construction, reduced fundraising ability of firms via securities markets, and decreased lending ability of financial firms. The 2008 crisis hit small businesses hard—more than it impacted large firms. Notably, these businesses forced layoffs, halted expansion plans, or closed outright.
With SVB, the environment in which this has happened is crucial to explaining the after-effects. Before the collapse, the Federal Reserve kept raising interest rates. SVB was highly invested in long-term treasury bonds when the rates were near zero. Unfortunately, when interest rates rose, the prices of long-term bonds fell. Hence, their investments at the time cratered. Still, some argue that this was merely an unrealized loss and that the bonds would have eventually recovered upon maturity. But when the news got out, the market panicked sharply. SVB lost USD 160 billion in 24 hours. As they watched the stock fall, depositors wanted their money back.
It has been stated that one of SVB’s prime weaknesses is that it mainly catered to a single industry. Thus, the bank run on SVB affected early-stage tech start-ups the most. The US government swiftly resolved the problem and made all depositors whole. The Federal Deposit Insurance Corporation, or FDIC, took over SVB promptly, recognizing systemic risk.
As stated previously, the effect on business mostly impacted early-stage tech start-ups. In a sense, the crisis of 2023 isn’t the same as the crisis of 2008. However, the banking crisis continues to unfold, and only time will tell whether the unprecedented US government backstop successfully halted a full-on financial crisis on top of a looming recession, or only delayed it.
Banking Crises’ Impact on Businesses
During the 2008 crisis, credit markets seized up. Thus, businesses needed help accessing the financing to fund operations, expansion, and investments. Moreover, there was a tightening of lending standards. It became more difficult for small and medium-sized enterprises (SMEs) to obtain credit.
Due to the crisis, consumer confidence and spending declined, further dampening business revenues and profitability. The banking system’s lack of liquidity also hampered day-to-day operations, as businesses struggled to meet payroll, pay suppliers, and maintain cash flow. Many companies were forced to downsize, lay off employees, or shut down entirely.
We can see how such vulnerabilities of the past persist in 2023. A similar state of affairs in the banking sector could still harm businesses.
Today, the rapidly rising levels of corporate and sovereign debt, geopolitical tensions, potential asset bubbles, and technological disruptions pose risks to financial stability. Should a severe banking crisis happen, likely started when a bank fails and triggers a run, it could once again disrupt credit flows, squeeze liquidity, and dampen economic activity, affecting businesses across industries.
How Businesses Can Protect Themselves From a Banking Meltdown: 5 Survival Tips
History shows why business owners must prepare contingencies beforehand for a banking meltdown. SVB, Signature Bank, and First Republic Bank collapse may seem like an outlier event, but almost 200 US banks have similar risk profiles.
Diversify Banking Relationships
Business owners should spread their bank accounts across different banks instead of relying on a single bank. It’s important not to rely on just one—businesses must try to work with several financial institutions.
When you diversify your banking relationships and have multiple bank accounts, you lessen the chances of losing the bulk of your funds in case of a bank failure. Having various banks also allows business owners to compare services, fees, and interest rates among savings accounts to ensure they have the best banking arrangements for their business.
Get FDIC Insurance and NCUA Coverage
The US Federal Deposit Insurance Corporation, or FDIC, provides deposit insurance for banks, while the National Credit Union Administration, or NCUA, offers similar coverage for credit unions.
Maintain Sufficient Cash Reserves
Ideally, your business should have a financial cushion or emergency fund saved up. Set aside a portion of your company’s profits in a secure account separate from your operational funds. It would help if you automated your accounting system and got IT support to monitor your operations and properly track cash flow.
Evaluate Your Bank
We’ve heard all kinds of complaints about banks. Feel free to go on a fact-finding mission to determine if your bank is stable. Check if the FDIC or the National Credit Union Administration insures your bank. If so, your deposits are insured for up to USD 250,000. Assess your bank’s concentration risk. As with SVB, banking relationships can be concentrated on a specific industry and may carry some risk with it. Banks should cater to a diverse customer base to be more risk-averse.
Look for signs of deteriorating performance or any regulatory concerns. Stay informed about any mergers, acquisitions, or management changes, as these can impact the stability and direction of the bank.
Have Alternative Financing Options
Look beyond traditional banking institutions and explore alternative financial services and financing options for your business. Consider business credit unions, crowdfunding, and peer-to-peer lending platforms as alternative avenues for capital access. Diversifying your financing sources increases the chances of securing funding during challenging economic times.
Preparation is Key to Protecting Your Business From Financial Shocks
There are economic and financial events that are beyond our control. As a business, stopping another banking meltdown is not within your power. You cannot decipher the complex web of transactions in the financial world that may lead to some potential unraveling. However, you can take proactive steps to protect your interests and assets.
These are steps you can take as early as today. By diversifying banking relationships, monitoring the health of your bank, exploring alternative financing options, and maintaining cash reserves, you can fortify your business against the potential consequences of a bank failure. Furthermore, by staying informed and seeking professional advice, you can make informed decisions and adapt swiftly to changing circumstances.
Don’t be reactive. Instead, prepare. Gather information, get the necessary insurance, and allocate assets in a diversified manner. Preparation is crucial to weathering financial storms. Take steps today—the sooner, the better—to ensure your business’s long-term success and stability.
