U.S. Banking Systemic Risks

“This isn’t the start of a banking crisis,. It’s markets waking up to the fastest rake-hike cycle since the 1980s — and the growing risk of recession.” – John Authers and Isabelle Tanlee

The Federal Reserve’s monetary actions have been a financial and economic rollercoaster for America.  They have printed trillions of $US dollars, insisted that inflation was transitory, suddenly raised federal fund interest rates, and created conditions that precipitated an economic crash. Banks, real estate, and highly leveraged businesses are all facing tough times ahead.

US banking system as a whole is solid, but that does not mean that every regional and community bank is strong. Some banks are sitting on big unrealized losses on loans and securities. They don’t appear on the balance sheet because loans and securities are held at book value and not marked to market (or current market) value.

Banks of regional and community bank customers have been withdrawing money from these smaller regional banks and moving their funds to perceived safe alternatives such as larger banks and/or investing in money markets and Treasury Bonds.

Yet, President Biden administration’s actions of implicitly guaranteeing all deposits have not eliminated completely the threat to the financial system. Due to the volatility in U.S. Treasury bond yields after the the prior protracted period of leverage-enabling policy, the most vulnerable currently are those vulnerable to both interest rate and credit risk.

Contagion risk and the systemic threat can be easily contained by careful balance sheet management and avoiding more policy mistakes.  However, it is believed that customers may leave smaller regional banks for larger ones as they associate the former with risk in the wake of Silicon Valley Bank’s failure. The flow of deposits will be a key measure of the public’s confidence in regional banks over the next few weeks. We also expect to see more flows into money market funds from bank accounts as investors seek to not only earn higher yields but also move some money away from the banking system as a whole, in the short term.

Creating a banking system where all uninsured deposits (greater than $250K) become fully insured through the FDIC or taxpayers also poses systemic risks.


References:

  1. https://www.lazardassetmanagement.com/us/en_us/references/banking-update/commentary
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