EJ_Rodriquez
In a context of high interest rates in the United States, the country’s banking system is vulnerable in the sense that some institutions could suffer funding pressures and weaker capital levels, the Federal Reserve Bank of New York wrote in a recent Liberty Street Economics report. blog entry.
More than a year ago, the Federal Reserve began raising interest rates to the highest level in 22 years. That, in turn, led to increases in unrealized losses in banks’ securities portfolios, which “may induce funding shortages and substantially weaken effective capital levels,” Fed staff wrote. from New York. A high-profile example: the bankruptcy of Silicon Valley Bank earlier this year, the roots of which arose from the dislocations caused by the high-rate environment.
“The March 2023 banking crisis highlighted the vulnerability of the banking sector to a sudden increase in interest rates,” the blog authors explained. “Specifically, banks’ ability to limit the transmission of rate increase cycles to deposit rates allows them to benefit from higher rates, but only gradually.”
Although risks to the banking system are increasing at a modest pace, they are still below levels that preceded the 2008 global financial crisis, the blog noted, citing its assessment of analytical models through the second quarter of 2023. It is partly because larger banks like JPMorgan (New York Stock Exchange: JPM), Citi group (New York Stock Exchange:C) and Bank of America (New York Stock Exchange: BAC) are less exposed to capital shortages and bank run risks than smaller regional lenders.
The capital vulnerability index based on the 2008 crisis stands at around 1.55% of gross domestic product, a historically low level, the blog noted. Based on a scenario equivalent to a rise in interest rates in 2022, the index “currently remains somewhat elevated compared to recent historical standards.” This vulnerability originates from banks’ exposure to a sudden drop in the value of securities following a hypothetical additional increase in interest. rates.”
In the current environment of higher rates for longer, especially amid the March banking crisis, depositors flocked to higher-yielding alternatives, primarily money market funds. This is largely because banks have been slow to raise deposit rates, yet quick to raise lending rates, as that would threaten net interest margin.
Another risk is that high rates will drive more deposit outflows, as well as increase losses on institutions’ securities holdings that would require more funding and weaker capital levels. Note that capital outflows have slowed since the March bank failures, as the Federal Reserve appears to be nearing the end of its tightening campaign.
To shed more light on how the broader banking system is faring, the fire-sale vulnerability index, a hypothetical measure of banks’ vulnerability to a systemic asset fire sale, remains elevated but has slowed some of the rise. March, the blog says. saying.
Additionally, the liquidity stress index, which measures banks’ potential liquidity shortfalls under stressed conditions, has been rising since early last year, “driven by a shift from liquid to less liquid assets and from stable to unstable financing.” “. The execution vulnerability index has also been increasing since early 2022 along with leverage, illiquid assets and unstable financing.
US Regional Banks: US Bancorp (USB), PNC Financial (PNC), New York Community Bancorp (NYCB), Axos Financial (AX), KeyCorp (KEY), Regions Financial (RF), Huntington Bancshares (HBAN) Truist Financial (TFC), Fifth Third Bancorp (FITB) and Comerica (CMA).
