The collapse of several high-profile banks is sending shivers through the financial markets and raising questions about the health of the US banking system.

The most recent casualty: San Francisco-based First Republic Bank, which was seized by regulators recently and acquired by JPMorgan Chase in a deal designed to avoid a disorderly collapse of the bank.

First Republic’s demise marks the second-largest bank failure in U.S. history by assets and follows hard on the heels of a handful of headline-grabbing bank failures, including the collapse of Silicon Valley Bank (SVB). Could First Republic’s failure potentially rekindle the recent banking crisis?

We asked Columbia Business School faculty to weigh in on the First Republic deal, the outlook for the banking sector, and the implications for the Federal Reserve.

Here’s what they told us:

CBS: Why is First Republic in trouble now, one month after SVB?

The main story is that when interest rates rise, the value of an existing loan falls. Banks hold lots of loans that were made previously, at lower interest rates. When interest rates rise, those old loans, made at low rates, offer only low payments to the bank while the bank's cost of funding rises. When a bank’s assets – their loans – lose value, the bank doesn't have as much money it can raise to pay depositors. Depositors get nervous that they might not get their money back and run to withdraw it before the bank fails.

– Laura Veldkamp, the Cooperman Professor of Economics and Finance

What happened with First Republic is consistent with what we are seeing at large. The banking crisis is happening sequentially with the weakest bank, SVB, going first. Around that time, people became concerned about other banks, including First Republic, which received $30 billion of timed deposits from large US banks in March 2023 after the SVB closure, so investors and depositors waited to see whether this emergency deposit injection was enough to resolve the remaining concern for the banks. However, when First Republic disclosed its first-quarter 2023 earnings, crucial information about how much of their deposits outflowed on the liability side, and how many unrealized losses they are sitting on the asset side due to the interest rate hike, was also revealed. The concerns of investors and depositors have escalated, the stock price fell, and deposits would have been withdrawn. Eventually, the bank regulator stepped in and closed the bank to prevent a negative spillover to other banks.

– Sehwa Kim, assistant professor of accounting

Large deposit flight in the first quarter, which was worse than the market expected when they announced earnings on April 24. A roughly $5 billion mark-to-market loss on their 10-K relative to $17.5 billion in book equity. A plunging stock price, which creates a loss of confidence. Perhaps some other idiosyncratic balance sheet issues, too, such as low-rate jumbo mortgages with large mark-to-market losses.

– Harry Mamaysky, professor of professional practice

CBS: Do you believe the Fed should take action to prevent any further bank failures? If so, what?

The Fed is in a difficult situation. On the one hand, we'd like to see them stabilize the banking sector to prevent a possible recession. On the other hand, bailing out bankers and bank investors who made bad decisions isn't a great policy. It's not very fair. As “normal” people, we don't get bailed out when we make mistakes. It also encourages risk-taking in the future. Risk-taking by banks becomes “heads, the bank wins, tails, the taxpayer loses.” Those are good gambling odds for the bank.

– Laura Veldkamp

The Fed took a lot of different steps including selling First Republic to JPMorgan. For this moment, the instability of the banking system has been stabilized, but people are still proposing different resolutions in the long run. Among them, two important accounting-related issues need to be addressed. First, we need to sort out the classification of debt securities. In particular, there are several loopholes in accounting standards that banks have employed to reclassify their debt securities from available-for-sale (AFS) to held-to-maturity (HTM) securities because banks don't have to recognize HTM securities based on market prices on their balance sheets. Importantly, HTM classification is determined based on a bank's intent and ability to hold the securities involved to maturity, which may be challenging under unusual situations like the recent period. Therefore, the classification of debt security needs to be revisited going forward.

Another important accounting issue is the AOCI (accumulated other comprehensive income) filter. The AOCI filter removes banks’ AOCI – a component of owners’ equity that includes cumulative unrealized gains and losses on AFS securities – from the calculation of Tier 1 regulatory capital. Since 2014, the AOCI filter was removed for “advanced approaches” banks with assets above $250 billion or foreign exposures above $10 billion under the US.adoption of Basel III, but other banks still maintain the AOCI filter in their regulatory capital calculation. As a result, banks with the AOCI filter have incentives to hold riskier AFS securities, which creates larger unrealized losses when interest rate hikes happen. We should also consider how we can make regulations more consistent across all banks in the United States and possibly remove the AOCI filter for all banks, consistent with other European countries under Basel III.

– Sehwa Kim

Yes, absolutely. More bank failures, especially large ones like First Republic, would be enormously damaging to the market. I don't buy into the moral hazard argument because banks have large amounts of capital between equity and depositors that are institutionally held, and these parts of the capital structure are taking big hits. This provides plenty of incentive to institutional owners to monitor banks. I don't believe depositors can really do this job anyway.

– Harry Mamaysky

CBS: What is the most important thing we should keep in mind now that JPMorgan has acquired First Republic?

Having one bank buy another is a good solution. But it, too, has a downside. It means that large banks are gaining ever more market share and market power. They can act more like monopolists, with less competition, giving depositors worse deals. This is a tough situation, with no perfect solutions.

– Laura Veldkamp

There are pros and cons to the regulatory action the Fed took. Basically, JPMorgan took over First Republic, and this is a desirable outcome in the short run because JPMorgan is the biggest and arguably one of the strongest banks in the US banking system. So the stronger bank took care of First Republic, which is important for the banking system as a whole. The concern is that we know that the too-big-to-fail issue is an important one for banking stability, and JPMorgan is already enormous. First Republic’s assets were more than $200 billion, and now JPMorgan is consolidating another large bank in a similar form of the government subsidy. So we should think about whether this is the best outcome for the banking system in the long run as more consolidation likely leads to more significant system risk.

– Sehwa Kim

The banking system overall is in good shape. The regulators are standing behind depositors, which creates confidence and prevents capital flight. The big banks are getting bigger and becoming too big to fail. Regional banks will be under earnings pressure because depositors can earn close to 5 percent returns in money market funds and T-bills. This will pressure the commercial real estate market because of the large role played by regional banks in providing CRE financing. But overall the banking system remains in pretty good shape.

– Harry Mamaysky