This chapter presents a discussion about the causes and consequences of the 2023 banking crisis in the United States. Using discourse analysis, the chapter shows that the 2023 banking crisis was the worst crisis in the US and Europe since the 2007-2008 global financial crisis. This banking crisis was caused by aggressive interest rate hikes by the US Federal Reserve. The increase in interest rates led to huge losses on the portfolio of government bonds held by US banks. The losses led to fears of bank collapse and triggered unprecedented deposit outflows which led to funding and liquidity problems for some banks and the eventual collapse of four banks – Silicon Valley Bank, Signature Bank, First Republic Bank, and Credit Suisse. This crisis showed that the increase in interest rates can unmask hidden vulnerabilities in the banking system.
Top1. Introduction
This article explores the causes and consequences of the 2023 banking crisis which began in the United States. Existing studies have identified several causes of banking crises such as poor risk management, ineffective regulation and supervision, weak corporate governance, high nonperforming loans, low capital adequacy ratio, and monetary policy (see, for example, Christiano et al, 2004; Taylor, 2009; De Grauwe, 2010; Chava and Purnanandam, 2011; Ozili, 2018).
Monetary policy is often used to control inflation through changes in interest rate and money supply. Economists argue that monetary policy has been an indirect cause of past financial crises. For instance, Christiano et al (2004) and Taylor (2009) show that the low-interest rate regime in the U.S. beginning from 2004 led to a boom in subprime mortgage lending and the securitization boom which imploded in 2007 and 2008 (Taylor, 2009). This event led to the conclusion that the Federal Reserve’s low interest rate regime was a remote (or indirect) cause of the global financial crisis, but it was not a direct cause of the global financial crisis.
Recent events have also led economists to blame monetary policy as a cause of the 2023 banking crisis in the United States. In early 2023, central banks around the world began raising interest rates. The hike in interest rate led to a banking crisis in the US which led to the failure of some regional banks in the US and the collapse of a systemic bank in Europe.1 The collapse of Silicon Valley Bank, Signature Bank, Credit Suisse, and First Republic Bank led to a wave of financial instability issues2 and raised concerns that the crisis could spill-over to other countries. The banking crisis prompted regulators to issue unconventional deposit guarantees, such as granting full deposit insurance to all depositors to quell the banking crisis in the US and prevent it from spreading to Europe. Although this approach worked in the short-term, the literature on deposit guarantee schemes shows that granting full deposit insurance guarantee is costly, politically difficult to implement, it serves the interest of wealthy people, and it only works in an environment of high trust in government (see Yan, Skully, Avram and Vu, 2014; and Cerrone, 2018).
Although the crisis could be linked to raising interest rates in the US, the existing literature has not identified rising interest rate to be a direct cause of banking crisis in the US. There is a need to understand the role of rising interest rate in causing banking crises, with particular focus on how the rise in the central bank interest rate caused the 2023 banking crisis in the U.S. The insights gained from such analysis can help central banks to consider the ramifications of interest rate hikes in the financial sector. This study offers a unique perspective on how government policy can trigger a banking crisis.
The discussion in this paper contributes to the banking crisis literature (see for example, Laeven and Valencia, 2020; Iacovone et al, 2019; Nguyen, 2022). The present study adds to the literature by examining the role of monetary policy in causing the US banking crisis. It show that rising interest rate is a potential cause of banking crisis in the US. The study also contributes to the monetary policy literature that analyse the consequences of monetary policy decisions (see, for example, Wang et al, 2022; Amberg et al, 2022), It shows that an unexpected rise in interest rates can have unintended consequences on the banking sector. Finally, the study stirs up policy debates about deposit insurance and whether full deposit insurance can bring an end to a banking crisis.
The rest of the paper is structured in the following way. Section 2 presents the review of literature. Section 3 identifies the causes of the 2023 banking crisis. Section 4 presents some real-world bank failures that occurred during the 2023 banking crisis. Section 5 identifies some effects of the 2023 banking crisis. Section 6 discusses the role of full deposit insurance in preventing a future bank run. Section 7 presents the conclusion of the paper.