Original Article: CU Times

The rapid failure of Silicon Valley Bank (SVB) has caused a significant ripple effect throughout the entire financial system. The swift loss in confidence in SVB, which ultimately caused its demise, had investors scared, which led to many like banks losing significant amounts of equity and value. Since credit unions do not exist to attract Wall Street investors, their basic structure makes them uniquely resistant to stock market fears and anxieties.

What Caused the Sudden Loss in Confidence of the Financial System?

To understand exactly what caused the financial system to become fearful, it is important to understand how large banks with multiple investors measure value. Banks, for the most part, are designed to enhance the financial position of their investors. Bank owners are made up of investors who have purchased equity shares by giving the bank money in exchange for ownership. Bank management is incentivized and driven to return as much value back to the investors as possible because the free market generally allows investors to sell their shares and invest their money in another bank or company. Since management wants to keep current investors happy and hopes to attract more investors, creating value by reporting strong financial returns is a key strategic metric. One of the most important ratios they manage is called the price to earnings ratio.

With this background, we can examine what happened to SVB to cause its failure and set off a potential banking crisis. SVB depositors consisted of clients within the technology sector that had significantly large deposit amounts. When the COVID-19 pandemic began in March 2020, the Fed lowered interest rates to near zero, causing investors to seek financial gains outside the traditional financial system. That shift, coupled with significant stimulus payments, which were ultimately deposited into banks and credit unions across America, caused significant increases in deposits for SVB as investors placed their money into technology startups seeking larger financial returns. Due to this rapid increase and the need for SVB to show strong value to its investors, SVB was incentivized too quickly put those deposits to work to gain a return. Its leaders chose to do that by buying large amounts of long-term bonds and mortgage-backed securities, which, earlier in the pandemic, yielded just under 2.00%. This rate was considered a high yield at the time and the immediate monetary return outweighed the risk that their value would decrease in a higher interest rate environment. Fast forward to today and interest rates are on the rise to combat inflation, making those investments worth far less than they were when purchased. This is because a similar investment purchased today would yield a much higher return than those that sat on the balance sheet of SVB. Increased interest rates enticed less investment in the technology sector, causing overall deposits in SVB to shrink, which put pressure on the bank to obtain more cash. This was one reason why SVB chose to sell the investments it purchased during the early years of the pandemic at a $1.8 billion loss. It had planned on reinvesting some of the money into securities that yielded a higher rate to make up for the loss, but depositors became nervous and a massive run on the bank led to its failure.

Why Are Credit Unions Resistant to a Similar Outcome as SVB?

The fundamental structure of credit unions offers them a strong defense against a similar scenario because their focus is on their members, which are both their depositors and owners. At a bank, those who deposit funds are not necessarily owners, so management is not inherently accountable to their customers. In contrast, credit unions have no accountability to Wall Street investors. They answer only to their members, who are the same people who hold the loans and deposits on their balance sheets. These member-owners are comprised of the same people who live in the local community served by the credit union – the same member-owners that credit union employees see every day not only in their branches, but at the grocery store, at church, at restaurants and all over their communities. Credit unions saw similar growth to banks in recent years, but because their structure differs from a bank, their leaders’ decisions on what to do with those deposits differed. Since credit unions are not competing for investors, they were afforded more time to analyze and assess what types of investments would offer less risk while still providing a good return. Many credit unions decided to hold on to the cash and take the time to lend it out to their communities instead of chasing the immediate return by investing it all soon after it was received. This proved to be wise as interest rates increased.

The Takeaway

Though credit unions do seek returns on the deposits given to them by their member-owners, the source of their accountability drives them to do it in a safe and effective way. Most credit unions would much rather lend their deposits out to their communities because it directly benefits their member-owners. When you fund a mortgage loan for your neighbor, it builds your community and betters the life of your member-owner. When you give a loan to a small barber shop on Main Street, it improves the life of your member-owner and increases the value of your community. Credit unions are the safer place for people to put their money because of their passion to ensure their member-owners and communities thrive. This focus on their local area and the people who live within it influences credit union management to strive to create institutions that will endure and pay dividends to those who trust them to manage their funds wisely.