How is the USA stabilizing banks? Strategy after the 2023 crisis

The US Department of the Treasury implemented the Bank Term Funding Program (BTFP), offering loans collateralized by securities at par value to prevent a domino effect in the banking sector. This instrument represented a departure from standard monetary policy, as it allowed financial institutions to avoid selling bonds at market prices, which had fallen drastically in 2023 due to a series of interest rate hikes by the Federal Reserve. As a result, banks gained access to liquidity without the need to immediately book losses on portfolios of Treasury bonds and mortgage-backed securities (MBS), which in practice extinguished the fire in the regional banking system.

Liquidity stabilization mechanisms: Anatomy of a rescue

When Silicon Valley Bank collapsed in March 2023, the American financial system faced a crisis of confidence not seen since the days of Lehman Brothers. The problem did not stem from a lack of capital per se, but from the structure of bank balance sheets. In previous years, with near-zero interest rates, many institutions had invested huge sums in long-term Treasury bonds. When the Federal Reserve began aggressively tightening monetary policy, the market value of these assets plummeted. Banks that had to meet depositor claims faced a brutal choice: either realize massive losses on bond sales or go bankrupt.

The hastily introduced BTFP changed the rules of the game. Instead of valuing securities at their current market value (mark-to-market), the Fed agreed to accept them as collateral at par value. This solution allowed banks to obtain cash against collateral that would have been considered insufficient under market conditions. From an accounting perspective, this operation allowed the scale of the problem to be swept under the rug of liquidity, rather than forcing banks to restructure. Investors understood that the Department of the Treasury had drawn a new shoreline beyond which it would not allow any major player to drown.

The effectiveness of this tool was based on market psychology. Once it became clear that any institution could exchange its "toxic" bonds (in current conditions) for cash, the panic of depositors slowed down. Nevertheless, the price of this stabilization is high. Central banks, by acting as guarantors of asset value, remove the burden of responsibility for interest rate risk from bank boards. Previously, it was the bank that had to assess whether long-term bonds were appropriate collateral for short-term deposits. Today, thanks to the BTFP, this dilemma is no longer pressing, which, however, weakens market discipline.

The Department of the Treasury's reaction to institutional failures

The Washington administration, led by Janet Yellen, had to act under extreme time pressure. The failure of Signature Bank and Silicon Valley Bank triggered a barrage of questions about the safety of deposits above the statutory limit of $250,000. The Department of the Treasury used a systemic risk clause, which allowed for the protection of all depositor funds, thus going beyond the mandate of the Federal Deposit Insurance Corporation (FDIC). This decision was a signal to the market: we will not allow mass withdrawals, even if the cost of the operation has to be passed on to other banks in the form of higher insurance premiums.

In the context of crisis management, the BTFP became the foundation upon which trust was built. Yellen repeatedly emphasized that the priority is to protect small savers and businesses, but in practice, it was large financial institutions that benefited most from access to cheap money. The liquidity injection meant that the banking sector did not have to carry out mass sell-offs, which under normal conditions would have led to a recession caused by a credit crunch.

However, one must ask about the opportunity costs. By keeping banks in a state of quasi-activity, regulators have created an environment in which weak units are not eliminated, but "resuscitated." This phenomenon, called "zombie banking" in economics, leads to long-term stagnation. Instead of forcing consolidation or changes in business models, the BTFP allowed models that became archaic in the era of high interest rates to persist. Was this a deliberate strategy, or just a desperate move to buy time until interest rates start to fall? The answer to this question defines the current condition of the American financial system.

Market analysis: Volatility after a series of bankruptcies

The financial market in 2023 resembled communicating vessels, where one shock immediately transferred to other sectors. The rapid rise in Treasury bond yields caused bank portfolios to become a ballast. Stock investors, seeing how quickly capital was flowing out of regional banks, began to short the entire sector. Volatility in banking indices reached levels that, under other circumstances, would have heralded the collapse of the entire economic system.

The implementation of the liquidity program was a turning point. However, when analysts began to delve into the details of nominal valuation, doubts arose. Can an asset that is worth 80 cents in free trading and 100 cents under a rescue program be considered stable? This discrepancy became a hidden subsidy for the banking sector. Thanks to it, banks could continue operations, avoiding losses that would otherwise have had to be shown in quarterly reports.

For the individual investor, this situation is a warning signal. If the stability of the system depends on artificially maintaining asset valuations above their market value, it means that the true price of risk is hidden. In such a reality, markets stop allocating capital efficiently. Instead of financing innovative ventures, capital is "frozen" on bank balance sheets, waiting for better times. This hinders economic momentum and creates an illusion of prosperity that relies solely on liquidity provided by the central bank.

International cooperation on operational resilience

Global financial systems are interconnected in a way that precludes acting in isolation. The stability of banks in the USA directly affects European or Asian markets, which forces regulators to synchronize actions. As part of initiatives such as FSOR (Financial Sector Operational Resilience), supervisory authorities are working on standards that are intended to detect threats before they turn into a liquidity crisis. The idea is for every institution to be prepared for a sudden change in market conditions without having to resort to extraordinary interventions.

This cooperation takes the form of exchanging information on systemic risks, but also on technical issues, such as transaction collateral. Danmarks Nationalbank, like other central banks, places great emphasis on ensuring that financial institutions do not rely solely on external liquidity. Operational resilience is the ability to survive a shock using one's own resources. However, in the face of the digitalization of banking, where fund transfers take place in milliseconds, traditional protocols are becoming insufficient.

It is worth noting that even the best-prepared plans do not take into account the human factor of panic. Digital banking has meant that a "run on the bank" no longer requires physical presence at a branch – a few clicks in a mobile app are enough. This phenomenon radically changes the nature of crises. While regulators once had days or weeks to react, today hours count. Are technical protocols able to keep up with the pace of capital flows in a world where information spreads instantly? The answer is: no. That is why the BTFP was needed to physically stop the outflow of capital by creating a liquidity barrier that, in theory, was supposed to be impassable.

Lessons from history: Comparison to monetary experiments

Historical experiences, including the Bank of Japan's experiments from the 1990s and later, show that long-term reliance on cheap money leads to the atrophy of market mechanisms. The Japanese case of "lost decades" is a warning to any country that decides on extraordinary support for the financial sector. When the government begins to guarantee the outcome of investments, the incentive for efficiency disappears. Banks, knowing that in case of problems they will receive help in the form of preferential loans, stop caring about the quality of their credit portfolios.

Managing interest rate risk has ceased to be a challenge for American banks and has become a routine in which the main role is played by waiting for help. If the central bank always comes to the rescue, valuing assets above the market, then why hedge against falling bond prices? This is a classic example of moral hazard. In this situation, financial institutions take greater risks, counting on the fact that potential losses will be socialized, and profits will remain within the bank.

Analysis made by experts in mid-2023 indicated that the only way out of this impasse is to slowly withdraw support. However, any attempt to end programs like the BTFP raises fears about market stability. This is a liquidity trap from which it is extremely difficult to escape. An economy accustomed to cheap financing reacts to every increase in the cost of money like a heart attack. As a result, we are dealing with a "managed decline," where regulators try to lead the system out of the crisis so slowly as not to cause another shock.

Prospects for the banking sector: Beyond the horizon of the crisis

Today's reality of the banking sector is the result of lessons learned from 2023. Financial institutions, especially medium-sized ones, are under much stricter supervision. Capital requirements, which were previously treated as a formality, have become a key element of management strategy. Banks must maintain larger cash reserves, which directly translates into less aggressiveness in lending. For the average customer, this means more difficult access to loans, especially mortgage and investment loans.

We are also observing a process of consolidation. Smaller regional banks that do not have extensive compliance infrastructure are often absorbed by larger capital groups. This phenomenon leads to market monopolization. Although from the regulator's perspective this is beneficial – a larger bank is easier to control and has larger safety buffers – for the local economy it means a loss of relationship in the banking business. Banks are becoming impersonal corporations where credit decisions are made based on algorithms, not on knowledge of the customer.

Is the system safer? It is certainly stiffer. The stabilization tools used, including liquidity mechanisms, have created a foundation that makes it difficult for institutions to fail, but at the same time increases their ossification. A financial market in which every loss is amortized by the state loses its most important feature: the ability to self-correct. In the coming years, we will witness a long-term adjustment process in which banks will have to learn to live without a liquidity drip. However, if interest rates remain at a higher level for a longer period, the challenges associated with bond valuation may return, testing the durability of current regulations.

What this means for you

As a customer or investor, you must understand that the stability of the banking sector that we are observing is not the result of natural market forces, but of conscious state intervention. You benefit from the fact that your deposits are safer and bank panic has become a marginal phenomenon. However, you lose because the system has become less efficient, and the costs of debt and credit service remain under inflationary pressure. Money pumped into the system as part of rescue programs must find its outlet somewhere, which in the long run affects the purchasing power of the currency.

The catch is that as a society, we pay a hidden tax for this stability. Every rescue operation increases the state's debt or the central bank's balance sheet, which in the future limits the room for maneuver for fiscal policy. This does not mean that banks will collapse, but it does mean that their role in the economy will be increasingly limited to being a tool in the hands of regulators, and less and less to being a partner for entrepreneurship.

Questions and answers

Is my money in the bank safe after these events?

Yes, thanks to the intervention of the Department of the Treasury and guarantees of deposit protection, the risk of losing funds in institutions covered by support has been minimized. The banking system is currently being monitored for operational resilience more rigorously than ever before.

What specific tool helped banks avoid bankruptcy?

The key tool was the Bank Term Funding Program (BTFP). It allowed banks to take out loans collateralized by Treasury bonds and mortgage-backed securities, valued at their nominal, not market, value. Thanks to this, institutions avoided forced asset sell-offs during periods of falling valuations.

Did the 2023 crisis permanently change how banks manage risk?

Yes, these events forced the tightening of capital requirements and a change in the approach to managing bond portfolios. Regulators now place greater emphasis on operational resilience and the ability of banks to survive liquidity shocks without the need to use external rescue mechanisms.

What is the risk of moral hazard in the context of Fed actions?

This risk stems from the fact that by guaranteeing liquidity and asset valuation at par, the central bank removes the pressure on bank boards to manage risk carefully. As a result, institutions may make riskier decisions, assuming that in a crisis situation, the state will come to their aid anyway.

Why was nominal valuation so important for the banking sector?

In conditions of rising interest rates, bond prices fall. If banks had to value their bond portfolios at market prices, their equity could melt drastically, which would lead to the technical insolvency of many entities. Nominal valuation allowed this accounting "shock" to be avoided and liquidity to be maintained without having to show losses.

Is the consolidation of the banking sector beneficial for the customer?

This is a moot point. On the one hand, consolidation leads to the creation of larger, more stable institutions. On the other hand, it limits choice for customers and reduces the availability of financial services in smaller towns, where local banks were more flexible and better understood the needs of local entrepreneurs.

Sources

Article prepared by the Wiadomości PRO editorial team with the support of artificial intelligence. Facts come from the sources listed above.