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What if I told you the banking system is predicated on "faith?"

What if I told you the banking system is predicated on "faith?"

March 21, 2023


Because I gotta have faith, faith, faith…

No, not the George Michael song… Although, (don’t judge) that was one of my favorite songs from early childhood. Mainly because, the first time I heard it I was riding in the car with my sister. She is 17 years older than me, and when you are a kid, you idolize, and boy did I. She was older, cooler, out of high school and she was singing this catchy song and all I wanted to do is sing along too.

But I digress.


For those of us that go through life daily, without much fear, isn’t Faith what gets us through the ups and downs? I’m sure for some or in some scenarios, its perhaps blind ignorance, but for most, it is Faith.

Don’t get me wrong, in a lot of cases, both probably provide the same effect.

But today, I want to talk about Faith.

When posed with the question: “Are you afraid to die?” Those with strong Faith, will often be at peace, and can answer with a confident “No.”

I have seen that, both from those with strong religious backgrounds, as well as those with no religious background. But isn’t the underlying principle the same? Faith that it won’t matter because you don’t know/care what comes next and you won’t be here, so who cares. Or, Faith because you believe strongly in what comes next and therefore you have no reason to fear.

Both are beautiful, because the feeling is the same and it is liberating.

What if I told you the banking system is predicated on “faith?”

Our U.S. Banking system is built on faith. A multi-layered system of faith. It only works as long as faith is upheld, but stick with me on this, because I promise to end on the same beautiful feeling of liberation.

This day and age it is almost impossible to survive without some sort of banking connection. For businesses, it is next to impossible to operate any sizable business without a bank account. Every-day-consumers have a better chance of getting through life without a formal banking relationship, but I think we can all agree that our consumer habits would have to be drastically altered, in order to navigate a cash-only/bartering system.

We place faith in our banks that our money will be there when we need it.

Now, an understanding of how banks operate, and I will try to keep this as “cliff-notes” as possible.

If you didn’t already know how banks operate, the fallout of SVB, brought a crash-course to your footsteps.

The U.S. Banking system is built on Fractional Reserve Banking. Fractional reserve banking is a system in which only a “fraction” of your deposit is required to be available for withdrawal. When you open a bank account, your bank’s contract stipulates that you will allow them to use a portion of your deposits as loans to other bank clients. By loaning out your deposits, Banks are helping to drive economic growth in the community. In turn, you might receive interest on your deposit account (think Savings Accounts, Certificate of Deposits, etc.). In addition to making loans, Banks can invest in securities such as Treasuries and Mortgage-Backed Securities. 

The Federal Reserve Act of 1913 created the Federal Reserve System (the Fed) that we have today. Since that time, the requirements for banks to maintain a certain minimum threshold of deposits on hand (the reserve ratio), has changed. In March of 2020, the reserve ratio for all banks was reduced to 0%, and replaced with an interest crediting incentive. Interest on Reserve Balances (IORB) is a program by the Fed to pay eligible banks for maintaining these reserve accounts. Since the 1970s the reserve ratio has been between 8-10% for most banks, and the Fed paid separate interest on the balances of eligible institutions for those required reserves, called IORR (Interest on Required Reserves) and interest on excess balances, called IORR (Interest on Excess Reserves).

The greatest risk to the banking system (in my opinion) right now, is mob-like panic.

Remember faith?

If consumers run to their banks and demand to withdrawal their assets, mob-rule wins, and the system falls apart.

Don’t allow emotions to overpower your decision-making. History has shown us that more times than not, emotional decisions end up being the wrong decision.

The reality is, if you have fully insured deposits, there is little you should worry about. At the end of the day, there is not an alternative to a bank, that allows you to operate a business on a daily basis or maintain your consumer needs without drastic change to behavior. If we don’t continue to have faith in the banking system, then I’m not sure anything else really matters. Because, in a Dooms-Day scenario, cash won’t be worth anything.

I don’t say that to cause panic, I say that because if we give any consideration to a complete financial system failure, then we have to discuss the full extent of it. If anything, it should bring some relief, because in a “Dooms-Day” scenario, we will all be in the same boat.

What’s next for Banks?

Truth be told, there has already been incredible outflow of funds from banks, over the last year, well before the SVB fallout. High rates have generated competition for banks, and depositors have been moving money to higher earning accounts in a quest for yield and protection.

This is going to create a dilemma for banks. Raise the interest on deposit accounts to stem the outgoing flow of deposits, which will subsequently reduce the bank’s profit margins. Or, allow maturing assets to terminate without replacing them, in order to keep pace with declining deposits. This latter means reduced lending capabilities, and that will further negatively impact the current and delicate economic environment, and play right into the hand of the Fed.

Keep Faith.

In my February client letter, I stated: “Overall, we see a “muddle-through-economy” scenario forming for the next 18-mos, featuring both moments of euphoria and terror.”

The fears around the banking sector are one example of the feelings of “terror.”

In my opinion, if we want to place blame, it should be directed at the Fed and the Government. It has been their actions over the last several years, that have created this current environment. 

I personally, find it infuriating that the Fed’s stress tests of these banks in February 2023, did not include the current interest rates, in fact it used interest rate levels from February of 2022 (which was before the Fed started raising rates). But, I’ll save that rant for another day. 

“Be fearful when others are greedy, and greedy when others are fearful.” - Warren Buffett

We will soon have the opportunity to be greedy, and we have prepped for this since 2019. 

Disclosures: The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Investing involves risk including loss of principal. No strategy assures success or protects against loss.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Government bonds and Treasury bills are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.