A wide range of data and commentary indicate that both the banking panic is over and that it had only a limited impact on credit availability. The March panic was fundamentally a problem of a few poorly managed banks and not a crisis. Investors are no longer running to money funds and now appear comfortable again with the banking system. Overall bank lending activity was little changed in March and continues to grow in April. A number of regional banks also guided for continued loan growth in 2023, albeit at a slower pace than last year. These banks also indicated deposit rates may rise faster than anticipated, but not in an unmanageable way. This post reviews the stabilization in the banking sector, notes that the impact on bank lending appears limited, and suggests that even bank profitability will be fine.
The Panic is Over
The collapse of SVB generated market volatility, but was not indicative of broad weakness in the banking sector. Regional banks are by definition regional, so their troubles are confined to their region. The failure of SVB led to a panic in neighboring First Republic, but many banks outside of the Bay Area noted limited spillovers. The CEO of PNC, an East Coast based bank twice the size of SVB, explicitly noted limited impact on their business. SVB was unique in its fatal reliance upon a very flighty and concentrated deposit base.
Money fund data indicate that the investor community is again comfortable with the banking sector. The collapse of SVB led to a sudden aversion to bank credit risk that resulted in significant inflows into government MMFs, which can only invest in credit risk free assets. Even prime MMFs, which lend conservatively to banks, saw outflows immediately after SVB. The assets levels of both MMF types have since stabilized.
Bank Lending is Steady
Concerns over a potential bank “credit crunch” have thus far been unfounded. Bank lending standards have been tightening for months, but that does not mean that that standards are very restrictive. A tremendous lending boom took place in 2022 on the back strong economic growth and low interest rates, and now conditions are normalizing. Fed data show that bank loan growth continued in March at a healthy rate that is lower than 2022 but in line with historical data. The most recent weekly data indicates that bank loan growth continued steadily throughout the first two weeks of April.
A number of regional banks guided towards modest loan growth in 2023 and did not appear to be meaningfully impacted by the March panic. The banks generally remarked that moderating loan growth stemmed from tighter lending standards and lower loan demand due to higher interest rates. This is a trend that had already been in motion for months.
| Expected Terminal Beta | 2023 Loan Growth Outlook | |
| PNC | ~42% | 5-7% |
| Fifth Third | ~47% | 2-3% |
| M&T | ~40% | 1-3% |
| Key Bank | ~40% | 6-9% |
| Huntington | ~40% | 5-7% |
| Regions | 35% | 4% |
| Zion | ~45% | “slightly increasing” |
| Comerica | ~50% | 8-9% |
Profitability is OK Too
The March panic appears to have raised expected terminal deposit betas, but that does not mean the betas will be high. Deposit betas indicate the degree of pass-through of rate hikes to depositors, so higher betas would lower net interest margins. Regional banks widely expect terminal betas to be a bit above 40%, which is slightly above the last hike cycle but below that of the 2004 cycle. The historical data suggest banks can easily manage that level of deposit beta and the banks themselves indicated only slight lowering of net interest margins. Note that deposit betas increase slowly but are lowered rapidly, so eventual future Fed cuts would rapidly improve profitability.
Deposit betas will likely remain very manageable even if the Fed maintains a higher for longer stance. Unlike prior cycles, QE has left the banking system with an exceptionally high level of deposits in excess of loans. Recall, not long ago many banks were pushing depositors into money funds. The loan to deposit ratio of large banks remain around multi-decade lows, while those of small banks are below levels prevailing prior to 2020. QT will incrementally drain deposits, but it has not been a fast process.
Revisiting the Cuts
The March banking panic led to significant revision of the expected path of policy that may need to be revisited. Out of an abundance of caution, the Fed scuttled a potentially higher rate path and the market priced in aggressive rate cuts in the second half of 2023. The realization that the banking sector is not collapsing has prompted some repricing, and the eventual realization that it is actually healthy may prompt a further repricing.
33 comments On All Clear
As usual, a cogent and persuasive analysis!
Did you perhaps intend to refer to market pricing of rate “cuts” in h2-23?
Wow that’s a big typo. Fixed it – thanks!
Hi Joseph, thank you for sharing. Any thoughts from this:
https://www.linkedin.com/posts/with-rising-cap-rates-to-over-7-most-70-activity-7056283136980111360-_QLs?trk=public_profile_like_view
https://www.linkedin.com/in/rebel-c-b253391
great piece! any thoughts on the sharp reserve decline in the past week – and how tax flows into the treasury general account are draining liquidity from banks?
Great piece as always – do you think in hindsight, Fed made a mistake by not raising 50 basis points during last meeting?
Isn’t a large part of the unasked question how much the HTM portion of their portfolios are, and what the profile of the losses in those portfolios look like? If the duration of the HTM assets is pretty short any forced sales should produce manageable losses, but if that is not the case there is a chance that some banks are sitting on time-bombs, certainly the the ones that own a lot of CRE related assets. Triggering underwater sales because of deposits that move out then could get messy in a heartbeat.
A bank’s net worth is its assets minus liabilities. As you note – many banks have losses on their asset portfolio due to rising rates. However, their liabilities are also worth less as well. Deposits can in theory be withdrawn overnight, but are in practice like longer dated debt (which would also decline in market value when rates rise). See here for a good discussion.
From what I see credit losses are very manageable. Note that even spreads are pretty narrow.
HTM assets are recorded at cost unless it’s less than 1 year in maturity so the basic asset minus liabilities number is misleading unless it is adjusted for the unrealized P&L, no? Is at adjusted number healthy?
*that
Is there a way to edit a comment after it has been posted? I hate make spelling errors….
Isn’t it the other way around? Assets with high duration are more sensitive to interest rates changes. A short duration bond portfolio would fair better in a rising rate environment.
Any connection to recently plunging 1-month T-bill yields? They are at 3.5% now
But the risk/threat of the potential collapse of the commercial real estate still remains for the regional banks, right?
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Hi Joseph, what are you thoughts on the impact of the bank term funding program?
The program seems to have led to an infusion of cash into the banking system to the tune of almost $400B (?), or at least the Fed’s assets seem to have jumped by roughly that amount in the direct aftermath of the program:
https://fred.stlouisfed.org/series/WALCL
Maybe you have a better way to count this. Do you consider this irrelevant/insignificant? Did it have no role in ending the panic in your mind? If it did have no role, then why was it implemented, and why is it being used? I would love to hear your thoughts about its role!
Nice timing with FRC!
Title I mean, great article and very good points.
Mortgages issued by homeowners have to be retired at par when the homeowner sells the house. So a homeowner with a 3% mortgage , which may have a market value of 50 cents on the dollar , nevertheless has to pay 100 cents on the dollar to pay it off.
So- the owners of the mortgage ( banks, or pooled securities) dont suffer as mortgage rates go up. Sure the mortgage durations lengthen (negative convexity) – but the market price is irrelevant since the homeowner does not have an ability to buy back the mortgage at market value!!
The banking system in aggregate is swimming in reserves , currently around $3.5 T. Moreover the RRP is at $2.5T and if/when the RRP shrinks, reserves will correspondingly grow. Furthermore the reserve requiremnt is currently Zero.
The problem is the reserves are concentrated in the biggest banks , while the small banks are scrambling for reserves.
Its not a monetary policy issue ( which presumably targets the aggregate). Its more about bank regulations and bank management.
Everyone needs to compare the markets today to June 2022. In June 2022 the fed Funds Rate was at 75bp. It has been increased by 400bp since then. And what happened?
The 10yr T yield is about where it was.
Junk bonds are about where they were
Stock market , esp the big cap tech stocks much higher than June 2022.
Economy is doing fine,
Inflation rocketed up to 9% in summer 2022 and has since settled in at around 6% . The next up move in oil will take inflation even higher.
A few small banks got in trouble because they got caught wrongfooted on the rise in money market rates. But we dont have a system banking crisis.
So , 400bp in “rate increases” has tightened what exactly? The markets are laughing .
So 400 bp in “rate increases” has not tightened anything – what is everyone so concerned about another 50bp? What do folks think will happen?
What derails economic expansion is a shifting of demand deposits to gated deposits. And all monetary savings originate within the system. Contrary to the myopic banker, from the standpoint of the system, banks create deposits, they do not lend them. This shifting destroys the velocity of circulation.
Can you hear the sucking sound?
Small-Denomination Time Deposits: Total (WSMTMNS) | FRED | St. Louis Fed (stlouisfed.org)
Large Time Deposits, All Commercial Banks (LTDACBM027NBOG) | FRED | St. Louis Fed (stlouisfed.org)
Call it the paradox of thrift or precautionary savings. But from an accounting perspective, or flow, bank-held savings, stock, are frozen.
The point is that all monetary savings originate in the payment’s system. Demand deposits are just shifted into time deposits.
From the standpoint of the entire payment’s system, commercial banks never loan out, and can’t loan out, existing funds in any deposit classification (saved or otherwise), or the owner’s equity, or any liability item. Every time a DFI makes a loan to, or buys securities from, the non-bank public, it creates new money – demand deposits, somewhere in the system. I.e., all new and old deposits are the result of lending and not the other way around.
So, banks compete for the deposits that the system already owns. There is just a redistribution of deposits among the banks. Banks must maintain a positive “balance of payments”. Their core deposits must be “sticky” or a stable source of funds (unlike “brokered deposits”). And the larger banks have economies of scale. This results in the consolidation of the banking system.
See: “Should Commercial banks accept savings deposits?” Conference on Savings and Residential Financing 1961 Proceedings, United States Savings and loan league, Chicago, 1961, 42, 43. By Dr. Leland James Pritchard, Ph.D., Economics, Chicago 1933, M.S. Statistics, Syracuse.
See: “Profit or Loss from Time Deposit Banking”, Banking and Monetary Studies, Comptroller of the Currency, United States Treasury Department, Irwin, 1963, pp. 369-386
Any thoughts on this: “ “It’s spooky. Thousands of banks are underwater,” said Professor Amit Seru, a banking expert at Stanford University. “Let’s not pretend that this is just about Silicon Valley Bank and First Republic. A lot of the US banking system is potentially insolvent.””
The problem is that Reg. Q ceilings were removed by the DIDMCA (“allocation of funds across sectors”).
And the NBFIs are not in competition with the DFIs. Disintermediation is made in Washington.
“No member bank shall, directly or indirectly by any device whatsoever, pay any interest on any deposit which is payable on demand … The Federal Reserve Board shall from time-to-time limit by regulation the rate of interest which may be paid by member banks on time deposits, and may prescribe different rates for such payment on time and savings deposits having different maturities or subject to different conditions respecting withdrawal or repayment or subject to different conditions by reason of different locations.” – Section 11(b) of the Banking Act of 1933
“Regional Bank Crisis Spreads To Big Banks As PacWest, US Bancorp Tumble, Stocks Dump Amid Widespread Liquidations”
https://www.zerohedge.com/markets/regional-bank-crisis-spreads-big-banks-usb-tumbles-stocks-dump-amid-widespread-liquidations
Hi Joseph. I have always been in total agreement with you when it comes to the mechanics of the monetary system, but here I am a sceptic. Banks are failing and their sizes are not insignificant. Do you really think that these still surviving banks are going to expand their balance sheets now by making new loans, and risk their liquidity position in this environment? I think now the regional banks would use all the time they have to repair their balance sheets, and that means to de-risk. They can’t possible act like nothing had happened after the larger regional banks have met a quick demise. Therefore, I think we will see a significant credit pullback, especially to smaller borrowers (small banks lend to small businesses).
Reuters: “These officials also noted the Fed at some point could even lower short-term interest rates as it continues to draw down the roughly $8.5 trillion balance sheet, and that such a move would not be at odds with wider monetary policy.”
The FED should cut interest rates NOW – and continue with QT. The 1966 Interest Rate Adjustment Act is prima facie evidence.
If you wanted to destroy our country, you’d do exactly as Powell is doing. Powell thinks banks are intermediaries between savers and borrowers. So, he eliminated reserve requirements and destroyed deposit classifications.
See the GOSPEL:
http://bit.ly/1A9bYH1
Banks don’t lend deposits. Deposits are the result of lending. Ergo, all bank-held savings are frozen. It’s simply stock vs. flow.
Why do you think the regional banks are incurring outflows?
The deregulation of interest rates was a mistake. It’s just a repeat of the Great Depression.
Why do you think the commercial banks exclusively were saddled with Reg. Q ceilings?
Why do you think the ABA fought so hard to remove them?
You don’t think bank-held savings are frozen? See Dr. Philip George: “The Riddle of Money Finally Solved”
http://www.philipji.com/riddle-of-money/
Money is not neutral (“affect nominal variables and not real variables”). ” inflation continues to outpace Americans’ rising wages – for the 25th straight month”.
The FED is still too loose.
“We are all Keynesians now”. The Keynesian economists have achieved their objective, that there is no difference between money and liquid assets.
See George Selgin “I’m glad to see, upon reading on, that Prof. Summers explains himself in the comments. Still, I was taken aback upon first seeing this tweet by him attributing SVB’s troubles to its having done what all banks always do! (borrowing short to lend long).
From the standpoint of the system, never are the DFIs intermediaries in the savings->investment process. Never are the DFIs financial intermediaries (conduits between savers and borrowers) in the savings-investment process.
From the standpoint of the entire system and our domestic economy, commercial banks never loan out, & can’t loan out, existing funds in any deposit classification (saved or otherwise), or the owner’s equity, or any liability item. Every time a DFI makes a loan to, or buys securities from, the non-bank public, it creates new money – demand deposits, somewhere in the system. I.e., deposits are the result of lending and not the other way around.
The increased lending capacity of the financial intermediaries is comparable to the increased credit creating capacity of the commercial banks in only one instance; namely, the situation involving a single bank which has received a primary deposit and all newly created deposits flow to other banks in the system.
But this comparison is superficial since any expansion of credit by a commercial bank enlarges the money supply, whereas any extension of credit by an intermediary simply transfers the ownership of existing money.
Discounting under Volcker wasn’t at a “penalty rate”.
BAGEHOT’S DICTUM: the central banks should lend early and ‘without limits’ to solvent firms at a ‘higher interest rate’ with ‘good collateral’.
Discounting was made a penalty rate on January 6, 2003