Banks Are Blowing Up While the Economy is Strong. Time to Worry?
There is a fundamental difference between failures attributable to credit losses and failures attributable to interest rate mismatches.
My second child was born shortly after Silicon Valley Bank and Signature Bank failed.1 Since then, First Republic Bank has also failed, while the share prices of other large-but-not-enormous banks, including Truist, Keycorp, Zions, Comerica, Western Alliance, and PacWest have tanked.
First Republic, SVB, and Signature were the 14th-, 16th-, and 29th-largest U.S. commercial banks as of the end of last year, with $517 billion in U.S. assets among them. The Federal Deposit Insurance Corporation (FDIC) estimates that the cost of these three failures—which will eventually be borne by depositors in the rest of the banking system—will be $35.5 billion.2 The survivors that remain under acute pressure include the 7th-largest U.S. commercial bank (Truist) and hold more than $1 trillion in assets among them.
It is easy to be alarmed, and sharp analysts are already warning about “nonlinearities” associated with all of this. Others are not quite as pessimistic, but nevertheless believe that banks will eventually respond to rising funding costs and unrealized losses on long-duration loans and securities in ways that will impose a sustained drag on credit provision and economic growth. After all, American banks have lost roughly $800 billion (5%) in low-cost deposits since last summer, replacing them with “borrowings” from the Federal Reserve and Federal Home Loan Banks that now cost roughly 5% a year.
I may regret saying this, but I am less concerned. With the temporary exception of the Paycheck Protection Program (PPP) emergency loans, bank credit has not been a significant source of financing for either consumer or business spending. That is a notable contrast from pre-2007 cycles—and should help insulate the real economy from the disruptions in the banking sector. Moreover, the latest data suggest that growth in wage income and consumer spending (which translates into operating cash flow for companies) has been accelerating in 2023 compared to 2022H2, which should provide further cushion. The U.S. economy may yet end up rolling over in response to monetary and fiscal tightening, but fragilities in the banking sector are unlikely to exacerbate or precipitate a downturn.