Here Are 4 Things That Small Banks Must Do Now

In the wake of the largest bank failure since the Great Financial Crisis small banks are in a particularly special space. Small banks are needed now more than ever, but they must navigate the current environment with wisdom, a balance of protectionism and growth-orientation. The decisions made right now, especially for small banks, will put them in the category of acquirer or acquired in just a few short years.

Below are four things that small banks must do now if they seek to be vibrant on the other side of this current crisis:

1) Recognize That This Is Exactly What The Fed Wants

Jerome Powell wants to dramatically slow down the economy. In one Jerome Powell’s most potent speeches he made the case very clear for fighting inflation, slowing down the economy, and ignoring the other casualties of doing so. Specifically he said:

“If the public expects that inflation will remain low and stable over time, then, absent major shocks, it likely will. Unfortunately, the same is true of expectations of high and volatile inflation. During the 1970s, as inflation climbed, the anticipation of high inflation became entrenched in the economic decision making of households and businesses. The more inflation rose, the more people came to expect it to remain high, and they built that belief into wage and pricing decisions. As former Chairman Paul Volcker put it at the height of the Great Inflation in 1979, ‘Inflation feeds in part on itself, so part of the job of returning to a more stable and more productive economy must be to break the grip of inflationary expectations.’”

Jerome Powell, in his own words, leaning on the sagacious actions of his predecessors, wants to “break the grip of inflationary expectations.” Breaking a few banks on that path is of much lower importance. To achieve his seemingly-noble goal, lenders have to be more afraid of failure than they are afraid of missing growth opportunities without drying up the liquidity of the financial system – a tight balance.

What’s ultimately nice about the current financial decisionmaker setup of Jerome Powell as Fed Chair and Janet Yellen as Treasury Secretary is they can announce immediate relief for the banking system before the market opens on Monday morning to stave off contagion.

2) Access New Government Programs And Revitalize Your Federal Home Loan Bank Relationship

On Sunday, March 12^th, the government came to the rescue like it was 2008 all over again. The brand-new Bank Term Funding Program is a lightning rod of saving grace for banks. For the next two years banks can negate a significant portion of the negative impact of the Fed’s interest rate hikes on their liquidity specifically related to their government-secured assets. Ostensibly financial institutions can pledge government-secured assets at par value, irrespective of their current value. This matters because government-secured assets purchased 18 months ago are worth far less than par today because of higher interest rates. Based on the current term sheet a bank can pledge those assets today and then re-pledge again on/or before March 11, 2024. This provides two years of new liquidity options for banks but also opens the window for the Fed to lift interest rates to fight inflation without as much harm to the US financial system as there would have been on Friday, March 10^th.

But how much are small banks going to utilize this and other programs?

On an ongoing basis the 11 Federal Home Loan Banks offer the most attractive liquidity in the marketplace for small banks. However, small banks are less likely to maximize their utilization of the Federal Home Loan Bank’s liquidity and collateral programs versus their larger peers. It is more challenging for smaller banks to engage because of scale and other reasons, but there couldn’t be a more important time for small banks to hire, consultant with, or acquire the right talent to help them improve both liquidity and earnings through the Federal Home Loan Bank and the forthcoming government programs.

3) Get On Offense For Deposits

Within 48 hours of the Silicon Valley Bank failure, I received numerous emails from very large banks offering their operational treasury services and other supports related to demand and term deposits. These emails are an unequivocal hunt for deposits and client growth. How quickly will smaller banks be able to get their communications and marketing efforts roared up to take advantage of the unquestioned deposit shakeup that is officially underway now?

Silicon Valley Bank was not a small bank, so the way to message this is different than if it had it been a small financial institution. Small banks are best served to rely on their unique traits, customers service, their local presence, and their more personal relationships with depositors. Plan a visit to customers. Set up a special conference call to help customers understand how different your small or medium bank is relative to Silicon Valley Bank.

4) Improve The Bank’s Analytics Systems

On Sunday, March 12^th, one of my funds’ limited partners called and asked us to provide data on our exposure to Silicon Valley Bank, just two days after it was seized by regulators. On one hand the answer is zero, because we had no deposits with Silicon Valley Bank as of last week. However, exposure is rarely zero, because Silicon Valley Bank will not be the only financial institution to fail because of the Fed’s action and the current economy.

It was Silvergate two weeks ago. SVBVB
last week. Signature Bank this week. There will be more failures. As the whispers happen, management teams will be asked by their boards and investors about their multi-directional exposures. For companies, what is your exposure to this bank or that bank? What is the average loan to deposit ratio of the lending institutions that hold more than 25% of your working capital deposits? And so on. For banks, how much exposure do your business customers have with banks that could fail or with venture backed startups? While these are very serious questions that need quick answers most small banks are not positioned to respond to these analytics requests quickly (someone please say a prayer for all the junior analysts at banks). For small banks that want to thrive on the other end of this, investments in data and analytics technologies are going to be critical to not blowing up your operational capacity every time another bank fails or a new government program emerges.