(Fortune) - In the wake of Depression-era bank runs that caused thousands of financial institutions to fail, the government began doing something different in the 1930s—it created the FDIC and started insuring deposits. It was intended to make people feel confident in the banking system, and less likely to pull their money out.
Although SVB and Signature were covered by the Federal Deposit Insurance Corporation, the nature of their deposits—many uninsured and in a small amount of industries—has similarities with the 9,000 banks that failed in the 1930s, according to a new blog post by economists with the Federal Reserve Bank of New York.
The authors argue that like Depression-era banks in tiny rural communities, deposits with SVB and Signature were held by a small number of like-minded people, many of whom worked in the same industry and spoke with each other frequently. The banks also failed to control the narrative, which magnified the risk of a chaotic bank.
With their “concentrated and uninsured deposit bases,” Silicon Valley Bank and Signature Bank look “quite similar to the small rural banks of the 1930s, before the creation of deposit insurance,” the Fed economists wrote.
Parallels to the 1930s
During the first years of the Great Depression, thousands of bank failures led to $1.3 billion in losses for depositors. But the damage was likely magnified because of the lack of deposit insurance—individual bank customers were more likely to pull out their money out of a bank at the first signs of trouble.
“Before the FDIC was in operation, large-scale cash demands of fearful depositors often struck the fatal blow to banks that might otherwise have survived,” the FDIC’s website states. Many of those failed banks were dedicated to rural communities, with the majority of their depositors being local and employed in the agricultural sector.
Although SVB and Signature banks didn’t cater to small town farmers, the Fed economists pointed out that their depositors were also part of tight-knit communities—in finance, tech and law.
“Both SVB and SB had a depositor base that looked local, in that depositors reportedly interacted with one another in their regular business dealings,” they wrote. “SVB’s depositors were connected through venture capital networks and SB’s depositors were connected through law firm networks.”
Before its collapse, SVB had made a name for itself as the bank of choice for California’s startup and venture capital elite. Nearly half of all U.S. venture-backed startups banked with SVB, according to the bank itself, and its big gamble to concentrate on tech, which for years seemed like a good bet, eventually came back to bite it as a significant number of its clients were affected by evaporated VC funding over the past year.
Signature also had a concentration problem, as one of the only banks to offer services to crypto companies after many others began turning their backs on the sector earlier this year. Signature’s deposits were more diversified than Silvergate, a bank highly-focused on cryptocurrency that also collapsed in March, but was still reliant on customers from a relatively small pool of industries, as Signature was largely concentrated in banking services for real estate and law firms.
Because the bulk of both banks’ clients were companies, most deposits also exceeded the FDIC’s insurable limit of $250,000. In fact, the two banks had some of the highest proportions of uninsured deposits in the whole banking sector. Among banks with at least $50 billion in assets, SVB had the highest share of uninsured deposits at 93.8%, while Signature came in fourth with 89.3%, according to S&P Global Market Intelligence.
As many of the bank’s depositors knew each other professionally, the bank runs happened almost overnight, as account-holders spread panic on social media and instant messaging platforms like Twitter, Slack, and Whatsapp, with some venture capitalists telling their portfolio companies on group chats to move their funds out of SVB “as fast as possible,” magnifying the risks of concentration.
The New York Fed economists argued that the banks’ failure of communication and transparency was chiefly responsible for the sudden run, while advising other institutions to focus on managing narratives around risk that might threaten to erode confidence in future.
Like the small rural banks that failed a century ago, banks like SVB and Signature with highly concentrated and localized customer bases need to be adept at handling information to restore confidence before panic, which justified or not, undermines the financial soundness of banking institutions, the New York Fed economists wrote.
“Both SVB and SB, like the small rural banks before the creation of the FDIC, should have been acutely aware of the importance of managing the information about their balance sheet,” they said. “Looking ahead, our work emphasizes that banks need to remain aware of, and actively manage, the information about balance sheet risks that is presented to their depositors, especially in times of financial stress.”