First Republic Bank collapse incites fears for banking system and U.S. economy

On Monday, the Federal Deposit Insurance Corporation (FDIC) took control of First Republic Bank, the nation’s second-largest bank failure, and brokered its sale to JPMorgan Chase, according to The Hill.

The deal, which protects deposits, is expected to wipe out shareholders and make JPMorgan Chase the largest bank in the United States. The bank’s collapse raises questions about the strength of the U.S. banking system and the broader economy that relies on it.

The bank’s fate was sealed when it lost $100 billion in deposits after Silicon Valley Bank’s collapse caused panic among wealthy clients. Its stock plummeted 75 percent last week. It is unclear whether First Republic Bank is the final domino to fall in the recent banking crisis.

First Republic Bank relied heavily on wealthy clients, with more than two-thirds of its deposits surpassing the FDIC’s $250,000 insurance limit. While that was a lower ratio than at SVB, it was higher than other regional banks, prompting depositors to pull their money over fears of losing it.

The bank faced hefty unrealized losses on long-term Treasury bonds, which saw their value plummet after the Federal Reserve hiked interest rates, hurting its ability to raise cash to cover deposit outflows.

U.S. banks had $620 billion in unrealized losses on securities at the end of 2022, according to the FDIC. A March study from professors at New York University and Wharton estimated that their unrealized losses are closer to $1.7 trillion when accounting for all loans and securities.

The sector holds around $3.1 trillion in commercial mortgages, with small and regional banks accounting for 80 percent of those loans, according to Goldman Sachs analysts.

Banks can typically stomach those losses unless they face a bank run or market selloff. However, reduced access to credit will slow the growth of new businesses and hurt employers’ ability to invest in their company and hire more workers, experts said.

“The banking system touches many areas of our lives, from our own money to the money of the companies that employ us, and the economic stability of those companies,” said Callie Cox, investment analyst at eToro.

President Biden said Monday that the U.S. financial system is “safe and sound” thanks to the actions of federal regulators. He also called on Congress to hold bank executives accountable and urged regulators to strengthen regulations on big banks.

In a Friday report examining the cause of the March bank failures, Federal Reserve officials pointed to a 2018 law that loosened capital requirements and stress tests for banks with between $100 billion and $250 billion in assets. The Fed is considering tougher rules as part of its authority under the law.

The FDIC faced backlash on Monday for authorizing a deal that effectively allowed JPMorgan Chase to purchase a major bank’s assets at a government-subsidized discount. Critics said that regulators need to develop effective and fair guidelines to resolve bank failures, arguing that the FDIC wasn’t fully prepared for First Republic’s collapse.

“We should plan for those bank failures by focusing on strong capital requirements and an effective resolution framework as our best hope for eventually ending our country’s bailout culture that privatizes gains while socializing losses,” said Jonathan McKernan, a Republican FDIC board member.

To protect First Republic depositors, the FDIC is using an estimated $13 billion from its deposit insurance fund, which is paid for by fees on banks. Other experts argued that the agreement could cement the idea that only “too big to fail” banks are safe, threatening deposits at smaller institutions.

Robert Hockett, professor of law and public finance at Cornell Law School, said Congress should remove the FDIC insurance limit or risk allowing “financialized Wall Street banks to take all.”