Is the US banking crisis over?
- Written by George Kladakis, Lecturer in Financial Services, Edinburgh Napier University
The US banking crisis[1] triggered worries about the global banking system earlier in the year. Three mid-sized US banks, Silicon Valley Bank, Silvergate and Signature, fell in quick succession, driving down bank share-prices across the world.
America’s central bank, the Federal Reserve, made significant amounts[2] of cash available to the failed banks and created a lending facility for other struggling institutions. This calmed investors and prevented immediate contagion, with only one more US regional bank, First Republic[3], collapsing a few weeks later.
Yet it’s far from clear whether the crisis is really over. As traders return from their summer holidays to a period commonly associated[4] with upheaval in the markets, how are things likely to play out?
Tight margins and dwindling deposits
Central banks have continued to increase interest rates to counter sustained inflation in recent months. In July, the Fed raised its key interest rate to as much as 5.5%[5], the highest in 20 years. The rate was near zero as recently as February 2022.
Though the increases have slowed this year, such a sudden change can be very harmful[6] for banks – particularly[7] as part of the sort of U-shaped movement in rates that we have seen since the global financial crisis of 2007-09.
US benchmark interest rate, 2007-23
Based on 641 banks.
S&P Capital IQ[11]
Credit rating downgrades
The ratings agencies have added further pressure. In early August, Fitch downgraded[12] its rating of US government debt to AA+ from AAA. It cited a likely deterioration in the public finances over the next three years and the endless politicking around the debt ceiling, which is the maximum level that the government can borrow.
Sovereign downgrades often reflect problems in the wider economy. This can destabilise banks by making them seem less creditworthy, leading their credit ratings to be downgraded too. This can make it harder for them to borrow money[13] from the markets or potentially even from the Fed. This can then have knock-on effects in reducing[14] banks’ lending capacity, capital buffers for coping with bad debts, overall profitability and share prices[15].
US banks’ share prices 2023
Bank of America = blue; Citigroup = orange; Goldman Sachs = pale blue; JP Morgan = yellow; Morgan Stanley = indigo; Regional banks = purple.
Trading View[16]
Sure enough, a week after the Fitch announcement, Moody’s downgraded[17] the credit ratings of ten US mid-sized banks, citing growing financial risks and strains that could erode their profitability. It also warned that larger banks including Bank of New York Mellon and State Street were at risk of a future downgrade.
The other major ratings agency, S&P Global Ratings, has since followed suit[18], while Fitch is threatening[19] to do likewise. Our research[20] suggests bank downgrades are associated with making them riskier and more unstable, particularly when accompanied by a sovereign downgrade.
Having said all that, there are positives for US banks. Both interest rates and bank deposits are at least projected to[21] stabilise in the coming months, which should help the sector. Despite the overall decline in banks’ profitability, bigger banks[22] are reporting improved margins from charging higher interest on loans. Some of these banks also expect a boost from things like increased deal-making later in the year. Signs like those could help to bring more stability across the board.
In Europe, banks have seen reduced deposits[23] and net interest margins[24] in recent years, which helps to explain why Credit Suisse[25] needed to be rescued by fellow Swiss bank UBS in March. Yet European deposits and profit margins have been recovering in the most recent couple of quarters. At the same time, the European Banking Authority’s recent stress tests[26] concluded that large EU banks are robust.
UK banks appear to be in a slightly worse condition than EU banks. They remain resilient on their balance sheets, but their deposits have not[27] recovered to quite the same extent as in Europe. They have also been[28] adjusting down their profit forecasts in anticipation of further rate hikes by the Bank of England.
Regulatory intervention
To strengthen the US sector, the regulators are planning[29] to further increase the minimum levels of capital that must be held by large US banks (with assets worth more than US$100 billion (£79 billion)).
These plans to increase banks’ capacity to absorb losses are encouraging, though will take more than four years to fully implement. The Basel II[30] international banking rules were introduced to a similar end in 2004, but were not implemented in time to prevent the global financial crisis.
For the moment, the US banking system remains vulnerable both to shocks within the financial system and more general calamities. It will still be a few months before we can say with confidence that the worst is over.
References^ US banking crisis (theconversation.com)^ made significant amounts (www.federalreserve.gov)^ First Republic (www.forbes.com)^ commonly associated (www.bbc.co.uk)^ as much as 5.5% (www.nbcnews.com)^ very harmful (theconversation.com)^ particularly (papers.ssrn.com)^ St Louis Federal Reserve (fred.stlouisfed.org)^ money market funds (www.forbes.com)^ by almost 4% (fred.stlouisfed.org)^ S&P Capital IQ (www.spglobal.com)^ Fitch downgraded (www.fitchratings.com)^ borrow money (academic.oup.com)^ in reducing (www.sciencedirect.com)^ share prices (onlinelibrary.wiley.com)^ Trading View (www.tradingview.com)^ Moody’s downgraded (www.reuters.com)^ since followed suit (www.cnbc.com)^ Fitch is threatening (www.dailymail.co.uk)^ Our research (openaccess.city.ac.uk)^ projected to (www.fitchratings.com)^ bigger banks (www.reuters.com)^ reduced deposits (www.ceicdata.com)^ net interest margins (data.ecb.europa.eu)^ Credit Suisse (edition.cnn.com)^ stress tests (www.ft.com)^ deposits have not (www.ceicdata.com)^ have also been (www.spglobal.com)^ are planning (www.ft.com)^ Basel II (www.bis.org)Read more https://theconversation.com/is-the-us-banking-crisis-over-212214
