Bill Ackman Says $30 Bn Deposits For FRB Raises More Questions Than Answers.

Bill Ackman Says $30 Bn Deposits For FRB Raises More Questions Than Answers.

Activist investor Bill Ackman recently criticized the move by some of the largest banks in the United States to deposit $30 billion with First Republic Bank (FRB). Ackman’s concerns centred on the potential for financial contagion risk and the spread of systemic risk through the banking system.

The deposit plan was reportedly devised with US regulators and included contributions from JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, and Morgan Stanley. However, Ackman suggested that this move raises more questions than it answers.

Spreading the Risk of Financial Contagion

According to Ackman, the deposit plan for FRB is a misguided attempt to spread the risk of financial contagion and achieve a false sense of confidence in the banking system. The activist investor argued that this approach is a “bad policy” and could ultimately do more harm than good.

He also suggested that half measures don’t work when there is a crisis of confidence and that policymakers should act decisively to address systemic risk in the banking sector.

Ackman’s concerns stem from the fact that the deposit plan for FRB effectively pools the risk of these large banks, making them more interconnected and potentially vulnerable to contagion.

In the event of a crisis, the failure of one bank could spread quickly to others, causing a domino effect that could destabilize the entire financial system. By spreading the risk in this way, Ackman argues, regulators are creating a false sense of security that could ultimately make the system more vulnerable to contagion.

Ackman reaffirmed that he had no long or short positions in the banking industry. I’m really very worried about the possibility of financial contagion risk getting out of hand and resulting in significant economic harm and misery, he said.

What is Happening?

On Thursday, JPMorgan, Bank of America, and nine other banks announced that they would deposit $30 billion in uninsured funds with First Republic Bank (FRB) for a minimum of 120 days.

Ackman issued a warning that the Wall Street banks would be exposed and incur losses if FRB had a tidal wave of withdrawals and defaulted on its debts.

The billionaire investor and head of Pershing Square stated that the core issue, a lack of confidence in the banking system, has not been addressed by the big banks’ display of faith.

Simply put, banks generate revenue by accepting deposits from consumers and spending those funds in one of two varieties. They have two options: they either lease the money out and earn interest from the loans, or they may put it in relatively safe assets like US Treasury bonds and mortgage-backed securities.

As a result, they don’t have the cash on hand, making it challenging to handle a sudden spike in withdrawals. Due to its money being invested in long-term bonds that had fallen in value due to rising interest rates and a significant number of clients trying to withdraw their money simultaneously, Silicon Valley Bank failed last week.

On Friday, the Federal Deposit Insurance Corporation assumed ownership of the struggling SVB. Under a systemic risk exception, it consented to guarantee Sunday deposits at both that institution and another, Signature Bank.

What Might Occur Next?

Since last Wednesday, the price of FRB stock has plummeted 70% as investors worry that it, too, may fail. The San Francisco-based lender’s clientele shares the same demographics and concentration as SVB and has a significant amount of uninsured deposits and unrealized bond loss exposure.

The bank has made an effort to alleviate concerns by promising to accept another $30 billion in deposits from its competitors in addition to access to $70 billion in liquidity from the Federal Reserve and JPMorgan.

However, the danger of a withdrawal wave has caused S&P Global and Fitch to downgrade the lender’s credit rating to junk status.

Investors appear to concur with Ackman’s assessment that the Wall Street rescue was a “fictional vote of confidence,” as FRB shares were trading lower on Friday in premarket trade. He lauded FRB, saying it was a sound, well-run lender that wasn’t to fault for its current problems.

It’s not its fault that it’s involved in a bank run, he said. It does not deserve to fail. The stability of the US financial sector is allegedly what Ackman fears will be threatened by bank runs destabilising one lender after another.

That can deter banks from making loans, leading to a credit crunch that might harm customers and companies and affect the entire economy. Ackman stated, “I am really very worried about the potential of financial contagion spiralling out of control and inflicting tremendous economic damage and hardship.

“We need to stop this now,” he continued. “Tick-tock.” “Three dominoes have fallen, and another is on its way,” Ackman stated in an earlier tweet, referring to Silicon Valley Bank, Signature Bank, and Silvergate. “The fire must be put out quickly before it spreads into a firestorm.”

What is Ackman Seeking?

Ackman is urgently advocating for a temporary, system-wide guarantee on all US deposits because he thinks that would strengthen consumer confidence in financial institutions and deter bank runs.

To encourage more responsible behaviour from less creditworthy institutions, his longer-term approach is to increase the deposit insurance cap from its present level of $250,000 and impose greater costs on them.

Implications for First Republic Bank

While Ackman’s concerns focus on the systemic risk implications of the deposit plan, there are also potential implications for FRB itself. The bank has recently been the subject of increased scrutiny, with some analysts suggesting that it may be overvalued and at risk of a market correction.

The $30 billion in deposits from the largest US banks could help to stabilize FRB’s position. Still, it could also create expectations of continued growth and put pressure on the bank to deliver strong results in the future.

Furthermore, if FRB were to experience significant losses or a decline in its stock price, the deposit plan could amplify these effects and create a negative feedback loop. Investors may begin to withdraw their deposits, leading to a decline in the bank’s liquidity and potentially triggering a broader run on the banking system.

Potential Market Impacts

The deposit plan for FRB could also have broader market impacts, mainly if it creates a false sense of security among investors. If investors believe that the banking system is effectively insulated from systemic risk, they may become complacent and fail to take appropriate precautions to protect their portfolios. This could exacerbate any future crisis and make it more challenging to contain the contagion.

Furthermore, the deposit proposal might make already existing worries about the power imbalance in the American banking system worse. The fact that a handful of large banks can effectively pool their risk and prop up a smaller bank like FRB could fuel concerns about the potential for oligopolistic practices in the financial sector.

Conclusion

Bill Ackman’s criticisms of the $30 billion deposit plan for FRB highlight the potential risks and uncertainties associated with efforts to spread the risk of financial contagion in the banking system.

While the plan may provide some short-term benefits for FRB and the participating banks, it could ultimately create a false sense of security and make the system more vulnerable to contagion. Policymakers and investors must remain vigilant and proactive in addressing systemic risk in the banking sector to ensure the stability and resilience of the financial system.

Edited by Prakriti Arora