US banking industry at lowest ebbs
Editor's Note: The author is Executive Director of the Center for South Asia & International Studies (CSAIS) Islamabad and Regional Expert on China, BRI & CPEC. The article reflects the author's opinions and not necessarily the views of Gwadar Pro.
The ongoing U.S. banking crisis is steadily spreading and gaining momentum. Initially, Silicon Valley Bank, Signature Bank, and First Republic Bank faced troubles, and now Pacwest Bank, Western Alliance Bank, and First Horizon Bank are potentially heading towards default. This situation is concerning for the banking industry, financial sector, money markets, and even the real estate market. The spillover repercussions will likely impact the regional and global banking industry as well as the overall economy.
Despite multiple bank failures, the U.S. Federal Reserve Chairman, Powell, claims that the U.S. banking system is sound and resilient, citing the recent 25 basis points increase in interest rates.
However, multiple sources suggest otherwise. The Federal Reserve revealed that 722 banks reported unrealized losses exceeding 50 percent of capital in the third quarter of 2022.
Unfortunately, U.S. banks have experienced an outflow of $US1.1 trillion in deposits over the past year. Much of this has been transferred and invested in money-market funds offering higher returns and promising safety and stability during times of rising uncertainty.
To boost liquidity, the U.S. Treasury has announced its first buyback scheme in decades, which has its limitations and multiple effects.
The latest IMF report predicts that the U.S. economy, the world's largest, will expand by 1.6 percent this year, down from 2.1 percent in 2022. The global economy is also expected to grow by 2.8 percent in 2023, down from 3.4 percent in 2022.
There is a fear that the U.S. could enter a recession this year due to reduced lending from regional and community banks. After the closure of Silicon Valley Bank (SVB) and Signature Bank (SB), small depositors became fearful about the solvency of small and mid-sized banks. This undermined market confidence, and as a result, all U.S. banks lost $108 billion.
The IMF estimates that U.S. banks' lending capacity will decline by 1 percent this year, mainly due to the drastic fall in the value of many bank stocks as investors reassess the health of small and midsize banks. Regional and smaller banks in the U.S. account for more than one-third of total bank lending. If these banks reduce their lending activities, it could have a significant impact on economic growth and financial stability.
In its latest World Economic Outlook (2023), the IMF rightly warns about the significant risk of a banking crisis spreading to the broader economy and impacting business and consumer confidence. The U.S. economy is inching towards recession and high inflation, and financial market volatility is expected to increase, weakening the world economic outlook. Economic uncertainty will be a real concern.
A critical analysis of the prevailing banking crisis reveals that the mismanagement of monetary policy and interest rate hikes in the U.S. have played a significant role in this situation. Borrowing has become costly, and nonbank financial firms, including the hedge funds, private equity funds, and insurance companies, will be exposed to credit risk deterioration as the economy slows down. Even the commercial real estate sector will be in the line of fire.
To conclude, the U.S. banking sector is currently facing challenges and feeling the impact of the illogical continuation of hard monetary policy and interest rate hikes in the country. Rampant inflation and costly and unproductive borrowing due to the slowdown of the macro-economy have further exacerbated the situation.