Falling of regional banks, detrimental to US and global economy
JPMorgan Chase’s recent acquisition of First Republic Bank, which marks the latest fallout from the U.S. banking turmoil, might relieve U.S. regulators. But it failed to quell investors’ concerns over the U.S. banking sector.
Shares of several other regional banks — notably PacWest Bancorp and Western Alliance Bancorp. — tumbled after the failure of First Republic last week, as fears continue to spread across investors.
Despite stocks rebounding after a brutal week, more U.S. regional banks risk falling into trouble amid high interest rates and growing doubts among investors, which could be detrimental to the U.S. and global economy.
Fed takes blame
The collapse of San Francisco-based First Republic Bank, which followed the crashes of Silicon Valley Bank (SVB) and New York-based Signature Bank in March, marked the second-largest bank failure in American history.
“The turbulence we are seeing in the banking industry is the result of the Federal Reserve raising interest rates at the fastest pace in forty years and of the real commercial property market crisis,” Desmond Lachman, a senior fellow at the American Enterprise Institute, told Xinhua.
Last week, the Fed implemented the 10th interest rate hike in about a year, bringing the federal funds rate to a target range of 5 to 5.25 percent while hinting at a possible pause in its aggressive tightening cycle amid still elevated inflation, banking turmoil and growing recession risk.
Echoing Lachman’s remarks, David Kelly, chief global strategist with JPMorgan Asset Management, told Xinhua the “Federal Reserve waited too long to raise interest rates,” and now the shock from Fed’s aggressive monetary tightening “is really destabilizing the regional banks.”
Barry Bosworth, economist and senior fellow at the Brookings Institution, noted that the instability primarily reflects “a mismatch of maturity (liquidity) between deposits and bank assets.”
“They went long in a search for yield while forgetting that depositors could leave on a moment. Regulators were negligent in not stopping the buildup of risk,” said Bosworth.
The Fed already accepted some of the blame for the collapse of SVB, as indicated in a report published in late April. The U.S. central bank said its own supervisors were slow to grasp the extent of the vulnerabilities at the bank. When problems were identified, supervisors failed to take sufficient steps to ensure those problems were fixed.
“Following Silicon Valley Bank’s failure, we must strengthen the Federal Reserve’s supervision and regulation based on what we have learned,” said Fed Vice Chair for Supervision Michael S. Barr.
“This review represents a first step in that process — a self-assessment that takes an unflinching look at the conditions that led to the bank’s failure, including the role of Federal Reserve supervision and regulation,” said Barr.
The failures of three mid-size banks also put new scrutiny on a 2018 law signed by former President Donald Trump that rolled back some banking regulations.
“After the global financial crisis, Europe began reforming the sector, increasing capital levels and putting other safety buffers in place. But in the United States, under Trump, some of the regulations already in place for regional banks were loosened, allowing the banks to take greater risks,” said Giorgio Barba Navaretti, professor of economics at the University of Milan.
Barba Navaretti added that the banks most impacted in recent months in the United States were generally “less diversified” than their European counterparts in terms of assets.
Crisis not over
U.S. regulators seized control of First Republic Bank and sold it to JPMorgan Chase on May 1, attempting to contain a two-month banking crisis rattling the financial system.
Despite the government’s rescue deal, more U.S. banks may still face financial troubles, with risks to global financial stability.
“Just as we thought the crisis was past its worst, PacWest shares tumbled yesterday, raising the prospect that it might be the next U.S. bank to seek a buyer or raise new capital,” Russ Mould, investment director at British online investment platform AJ Bell, said on May 4.
Fear of contagion could follow bank failures, and that’s why regional banks such as the PacWest are still in a precarious situation. A loss of confidence could spark customers to withdraw their deposits en masse.
According to a Gallup poll released last week, nearly half of American adults say they are concerned about the safety of the money they keep in banks, including just under a fifth who are “very” worried.
A study on the fragility of the U.S. banking system found that 186 more banks are at risk of failure even if only half of their uninsured depositors decide to withdraw their funds, a recent USA Today report said.
“My expectation is that we will get a significant number of other regional banks failing as a fallout from high Fed interest rates and the real commercial property crisis,” said Lachman, a former official at the International Monetary Fund (IMF).
Lachman, however, added that the Federal Reserve and the Federal Deposit Insurance Corporation are well-positioned to contain any additional bank failures.
But bank failure is not the only fear. Kelly, the JPMorgan strategist, expressed concern about a credit crunch arising from the current banking turmoil and its drag on economic expansion.
“The problem of rising interest rates is undermining the economics of small regional banks. It’s going to make these banks much less willing to lend. I’m worried about a credit crunch, whereby small banks are less willing to lend to small businesses. That could cause the economies to slow down more rapidly,” said Kelly.
According to Kelly, the United States has more than a 50 percent chance of entering into a recession before the end of the year.
There is speculation that European financial institutions may be susceptible to the same issues that led to the U.S. banking crisis. In March, highly-indebted Swiss Banker Credit Suisse saw its shares battered by investors before UBS stepped in and agreed to buy its ailing rival.
U.S. banking turmoil has intensified concerns for EU banks, which are also under pressure amid higher interest rates, sending shockwaves through global financial markets and hammering the global economy.
“The downbeat sentiment has prompted falls in shares in UK listed banks including Barclays, HSBC, Lloyds, and NatWest,” Susannah Streeter, head of money and markets at Hargreaves Lansdown, a British financial service company, said in late April when First Republic Bank was making a last-ditch bid to find a rescue deal.
The Euro Stoxx Banks index, which offers exposure to more than 20 major banks across Europe, traded at around 102 late on May 10, which was still over 14 percent below its March 6 level, when news about SVB running into trouble broke out, showing that the distress of U.S. banks continues to weigh on the European banking sector.
“The weakness in U.S. markets is exacerbating the negative sentiment over concerns that the turbulence in its banking sector will drag the U.S. economy into recession, and where the U.S. leads, Europe inevitably tends to follow,” said Michael Hewson, chief market analyst at the London-based financial services company CMC Markets.
A recent Goldman Sachs report showed that the investment bank expects annual average GDP growth globally to slow to 2.5 percent in 2023, “reflecting ongoing drags from monetary policy tightening and banking stresses in the U.S. and Europe.”