March 29, 2024

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The Federal Reserve warns of the risks of a credit crunch after the turmoil of US banks

The Federal Reserve warns of the risks of a credit crunch after the turmoil of US banks

The Federal Reserve has warned that recent banking turmoil could fuel a broad credit crisis that threatens to slow the US economy, while lenders have told the central bank they plan to tighten lending standards over concerns about loan losses and deposit flight.

Two separate publications from the Federal Reserve on Monday highlighted growing concerns that the collapse of Silicon Valley and Signature Bank in March and the failure of First Republic last week will lead to declining lending and lower asset prices.

In its biannual Financial Stability Report, the US central bank said that despite “decisive action” by regulators and officials to address recent regional banking crises, concerns about “the economic outlook, credit quality, and liquidity of funding” may lead “banks and other financial institutions.” To further contract the supply of credit to the economy.”

“A sharp contraction in the availability of credit would raise the cost of funding for businesses and households, which could slow economic activity,” the Fed added.

The chance of a credit crunch has been cited as among the current greatest risks to the financial system, and not the most likely scenario for the Federal Reserve. But it did reflect concern about the macroeconomic impact of one of the most turbulent months in US finance since the global financial crisis in 2008.

“The credit crunch, or at least the credit crunch, has begun,” Austin Goolsby, president of the Federal Reserve Bank of Chicago, told Yahoo Finance on Monday. “I think you should say a recession is a possibility.”

Fears of a credit contraction come with the possibility of a US debt default looming as the White House and Congress deadlock over increasing the government’s $31.4 trillion government borrowing limit. An agreement must be reached by early June in order to avoid what Treasury Secretary Janet Yellen warned would be a “disaster” for the economy and markets.

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As part of its stability report, the Fed surveyed market professionals and academics. The share that ranked banking sector stresses as the biggest risk to stability has quadrupled since the fall, and now ranks par with inflation and US-China tensions. The survey found that concerns about commercial and residential real estate are rising rapidly.

Also on Monday, the Fed released the results of its quarterly chief loan officer survey, which found that banks expect to tighten lending standards in the rest of 2023. Bank officials cited concerns about recession and deposit withdrawals in the wake of the SVB collapse.

The largest banks, those with assets of at least $250 billion, have blamed a potential lending slowdown on an uncertain economic outlook, according to loan survey data.

Compared to the largest mid-sized banks [with between $50bn and $250bn in assets] The Fed has often cited concerns about liquidity positions, foreign deposit inflows and funding costs as reasons for tightening.

In an effort to retain depositors, some banks have had to offer better returns on savings accounts, which has affected profit margins. Medium-sized banks, which faced the largest deposit outflows, also cited concerns about tougher regulations and possible changes in accounting rules.

On how a potential credit crunch could spread more broadly, the Fed’s Financial Stability Report said there was a risk of a drop in earnings and an increase in corporate defaults. In addition, the accompanying decrease in investors’ appetite for risk could lead to significant declines in asset prices.

The Fed also warned of vulnerabilities in the commercial real estate sector, saying “the magnitude of the correction in real estate values ​​could be significant and thus could lead to credit losses by holders of CRE debt.”

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The central bank said it would also closely monitor the performance of commercial real estate loans and expand “screening procedures” for banks with a higher concentration in the sector.

On the less worrisome side, the Fed said “shocks in the financial system are unlikely to spread through the household sector because household borrowing is moderate relative to income, and most household debt is owed to those with higher credit scores.”

Even as the Fed warned that lending could take a hit, it said most banks seemed able to handle tighter monetary policy.

“Despite banking pressures in March, high levels of capital and exposure to moderate interest rate risk meant that the vast majority of banks were able to withstand potential pressure from higher interest rates. As of the fourth quarter of 2022, banks in total were enjoying Well-capitalized, mainly American banks of world systemic importance.

Additional reporting by Stephen Gandel in New York and Colby Smith in Washington