It has been more than six weeks since Silicon Valley Bank had to be shut down. Much to everyone's surprise, the banking system hasn't seen large trouble since. So, was it all much ado about nothing? There are clear signs that the banks are suffering, which is bad for the economy. 

Currently, we don't have signs that there are US or EU banks on the brink of collapse. There are no bank runs. But there are 'bank walks'. Slowly but surely, week after week, banks witness large deposit outflows. See this thread of analyst Jim Bianco for the numbers. He notes that it's not just the small banks that see deposit outflows: the large banks have even higher percentage outflows. 

Why do people withdraw money from their savings accounts? Because banks only pay up to 0.5% on deposits. Treasuries and money market funds can yield around 4.5%. In the current online banking environment, it's easy to move some money with a mobile banking app. Gone are the days when a person was more likely to divorce than to change bank accounts... 

Why don't banks raise interest rates for their depositors?

A large chunk of the banks' assets is based on what they loaned out before 2022. At those times, interest rates were much lower. And the so-called maturity of these loans is long, so banks are stuck in these positions. Remember that banks were selling mortgages in 2021, at fixed interest rates of 2%. They could not be a profitable business if they would currently offer depositors 4% on their savings account! 

So, the banks have no choice but to keep rates low and hope that not too many clients walk away. Economists and policy makers can only hope that this won't turn out to be more than a 'bank walk' and not a bank run. Only when the Federal Reserve will start cutting interest rates will banks have some breathing room - they will face less competition from money market funds. But that won't happen soon: the Fed is expected to once more raise interest rates with a quarter percent on May 3. 

What will be the effect on the economy?

A banking crisis is deflationary. When banks lose deposits, as is currently happening, they will have less room to lend out money. The smaller banks especially suffer from the current crisis. They lend out to local businesses, such as restaurants and smaller construction firms. If these companies don't have access to credit, the economy will suffer. 

The silver lining? The deflationary effect of this smoldering banking crisis will at some point force the American Central Banks' hand. It will be forced to cut rates and 'switch on the money printer' to stimulate the economy. That will help prices of stocks and... crypto. 

See also this article in the Wall Street Journal: Why the banking mess isn't over.