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The US Federal Reserve Solution to the current banking crisis likely to lead to More Pain in the Future

Opinion by Mwebya Fred: The US federal reserve has been faced with a serious banking crisis and its been a tough situation finding workable solutions especially with the current tension caused by the Silicon Valley Bank (SVB) crisis. From the available information, it is clear that the federal reserve solution seems great in the short run but will lead to more pain and hardships for the average American in the long run.

In order for us to understand this current crisis, we need to hark back on some key events that have been happening prior to the SVB saga. We all remember that before March 26, 2020, the United States financial system was based on fractional reserve banking. Fractional reserve banking is a system that allows banks to only keep a certain percentage of client deposits on hand. Fractional reserve banking allows commercial banks to do anything they find reasonable in order to make a profit. The banks can in this case decide to lend the money or even invest it in assets.

It is also important to note that the Federal Reserve Bank(Central Bank of the US) lends money to large banks and the US government. A lot of growth in the banking industry world over comes from lending and this is not any different for the US economy. When commercial banks lend money more easily, it means businesses are able to invest in operations and hire employees. On March 15, 2020, the Board of Governors of the Federal Reserve System announced a change to reserve requirements. On March 26, 2020, the US banking system was changed to no reserve banking. This simply meant that banks had all the rights to do whatever they wanted with all client deposits.

The earlier norm was that if clients wanted their deposits back at any point, the banks would need to have enough cash on hand to support all withdraws. If withdraws can’t be supported, the commercial bank would collapse. Silicon Valley Bank was one of such banks that was doing whatever it wanted with their clients’ deposits to make profits. This means that SVB could invest money into any assets of their choice irrespective of the time horizons for returns to materialize (remember that deposits can be withdrawn immediately while investments are long term, any poor calculations of time frames based on this fact can turn out disastrous).

Fortunately for the case of SVB, the bank had mostly purchased US treasury notes which are considered free from the risk of default. This clearly means that while the bank has enough assets to back up clients deposits, it doesn’t have enough cash to facilitate withdraws. This is what exactly led to the bank’s collapse in 36 hours because they did not have enough cash to satisfy the many withdraw requests.

On March 13, 2023, the federal reserve announced the Bank Term Funding Program (BTFP). This was created to support American businesses and households and assure that banks have the ability to meet all needs of depositors. This now means that Banks can now take even more risks with depositors money without worrying about huge customer withdraws at ago. In the case where a bank does not have enough money to support the withdraw requests, they can take a loan from the Bank Term Funding Program (BTFP) using bank assets as collateral. This sounds a very brilliant solution in the short run but lets dig deeper and see how this is going to create a tough future for Americans.

The new bank reserve requirement system means that banks can now buy many more assets as they want which will push prices up in the market. Banks now have the potential to pay executives and employees bigger bonuses and increase the price of goods for everyone. Banks can borrow money from depositors to buy more assets, then they use those acquired assets to borrow even more money BTFP if depositors ever want their money back.

This means that the individual (bank client) will not be able to store wealth because the currency is going to keep losing value. The American banking system has not been built to support individuals but rather financial institutions. Over the coming years, many Americans will be forced to sell their assets because they can no longer meet the payment obligations.

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