There's a running joke on Wall Street that a loss isn't a loss until you sell, but for American banks, nothing could be further from the truth.

According to the Federal Deposit Insurance Corp (FDIC), U.S. banks are sitting on a staggering $684 billion in unrealized losses on their investments as of Q3 2023.

Unrealized losses have jumped by 22%, or $126 billion, from the previous quarter and are now equal to roughly 33% of bank holdings.

Also known as a "paper loss," an unrealized loss occurs when the market value of an asset falls below the purchase price while the asset hasn't been sold yet.

The lion's share of bank paper losses comes from U.S. Treasury bonds and government-guaranteed mortgage-backed securities—an asset class that bore the brunt of the Fed's rate hikes.

In theory, banks can ignore paper losses and simply hold the devalued bonds until maturity. But that's a PR nightmare for a bank reporting billions of dollars in the red quarter after quarter.

As Wolf Street’s Wolf Richter reports, the losses "don’t matter until they suddenly do."

If depositors get spooked—akin to the lead-up to last year's banking collapse—banks could face yet another series of classic bank runs.

As Richter writes, 'he who panics first, panics best.

Calls to increase FDIC limits

Customer deposits became the source of legitimate concern during the March 2023 banking crisis, forcing the regulatory heavyweights—Federal Reserve, Treasury, and FDIC—to step in.

In total, five U.S. banks failed last year, wiping out more assets than the combined bank losses in the aftermath of the 2008 financial crisis.

Although FDIC insures up to $250,000 per account, many affected agency-backed deposits exceeded that level last year—urging the FDIC to call for higher insurance limits.

A report from the Stanford Institute for Economic Policy Research published in March 2023 said the FDIC would probably have to step in more frequently moving forward.

“Many U.S. banks face the same risks that brought down Silicon Valley Bank,” the report said, adding that the banking sector was sitting on $2.2 trillion in losses.

“Banks with “high levels of uninsured depositors and large losses are […] Prone to solvency crises that could trigger bank runs,” the researchers said.

Fed to the rescue?

The Fed is keeping a close eye on the paper losses on the bank books and is ready to step in if things go sideways.

In fact, last March, the central bank launched the Bank Term Funding Program (BTFP)— a last-resort lifeline for banks with excessive losses tied to government bonds.

As the Brookings Institute explains, the program allows banks to swap Treasuries for cash at their full face value, regardless of their current market value.

So far, the Treasury has allocated $25 billion to the program. The Fed thinks this is more than enough. And it probably is, at least until depositors break a sweat.