The sudden collapse and seizure of Silicon Valley Bank (SIVBQ) by the FDIC on March 10 caused a loss of confidence in the banking system. While analysis shows U.S. banks to be solvent overall, the concern about banks remained and became a global phenomenon. The challenge of analyzing bank safety is that a severe loss of confidence can actually cause an otherwise functioning financial institution to come under duress. This analysis uses a systematic methodology to monitor the strains on the banking system weekly via the U.S. Banking System Stress Monitor. Aside from the market pricing data and government money market mutual funds asset flows, the bank data come from the Federal Reserve’s H.4.1 and H.8 weekly reports, released on Thursday and Friday, respectively.
This week regional banks outperformed the S&P 500 for the first time since the crisis began. The megabanks have been supported by better-than-expected earnings and supportive forward guidance to start the earnings reporting season. The smaller bank earnings have generally not been as impressive but still were better than the dire expectations following the start of the banking crisis. Despite the better performance this week, the KBW Regional Bank index is down almost 21% year-to-date. As measured by the KBW Bank index, larger bank stocks declined nearly 17% year-to-date.
Credit default swap (CDS) prices are less well-known but available in real time. In simple terms, CDS functions as an insurance policy that investors can purchase that pays off in the event of a borrower’s default. A higher price of a CDS reflects a more significant probability of default of the borrower. CDS prices for four of the U.S.’s global systemically important banks (G-SIBs) fell and are at the lowest level since this crisis began.
A straightforward way to measure the stress in the U.S. banking system is the magnitude of bank support provided by the Federal Reserve via various facilities. The most common is the discount window, which banks generally avoid, but the facility can provide emergency liquidity. In addition, following the collapse of Silicon Valley Bank, the Federal Reserve announced a new facility to help banks meet withdrawal requests from depositors and restore confidence. The Bank Term Funding Program (BTFP) allows banks to borrow up the face value of any government bonds held in the bank’s portfolio at a very reasonable rate. The Paycheck Protection Program (PPP) facility was created in 2020 to provide support during the pandemic. Other credit is the support of the bridge banks, operated by the Federal Deposit Insurance Corporation (FDIC) until they can be sold or liquidated.
With the seizure of Silicon Valley Bank and Signature Bank
SBNY
, discount window and bridge bank credit usage soared. Previously, there was a significant shift from discount window borrowing to using the bank term funding program (BTFP). This week, discount window and BTFP usage rose for the first time since the peak of the banking crisis. In addition, the credit used by the bridge banks was unchanged as the FDIC made no headway in winding down the failed banks. Overall, the increase in Fed bank lending across all two available facilities is a small yellow light, but the odds are that the impact of the banking crisis is still receding.
There were bank deposit outflows across large, small, and foreign-related banks. Notably, the 25 largest banks, which include many midsize regional banks, gained deposits since the failure of Silicon Valley Bank, while the smaller banks and the overall banking system lost deposits.
This week’s outflow seems likely to be related to tax payments. U.S. banking system deposits fell by over $350 billion during tax season in 2022, so it would seem likely that further outflows should also be seen in next week’s report.
Government money market funds also saw outflows which bolsters the case that the decline in bank deposits was related to tax payments. Aside from the distortion from tax day, cash had been flowing into government money market funds, which confirmed the pressure on deposits to leave the banking system. Notably, the pace of inflows into government money market funds has moderated significantly since the apex of the banking crisis. This movement, also known as “cash sorting,” reflects savers reaching for higher yields while avoiding the credit risk at banks. Cash sorting started before the crisis began but seems likely to continue to some degree while short-term U.S. Treasury yields exceed the interest rates banks pay depositors.
Banks continued to make loans despite the crisis, but total bank lending was negative again this week, driven by large and foreign-related banks. Loan growth should be expected to slow if banks are forced to hoard extra liquidity to bolster their defenses against possible additional deposit flight and increased loan losses.
The first signs of a potential credit crunch in commercial real estate (CRE) lending appeared a few weeks ago when lending to that segment fell the most on record. CRE lending from small banks was again slightly higher this week. Smaller banks are the leading provider of commercial real estate loans, so that sector could face less credit availability.
Commercial and industrial (C&I) loans, which are business loans, have also declined at all banks over the past four weeks. C&I loans are generally viewed as tied to economic activity, so some combination of economic headwinds and tightening credit conditions at banks could be driving these declines.
In summary, despite some small yellow flashing lights this week, the U.S. banking system has improved from the extremes of the crisis. Small and large banks had deposit outflows, likely related to tax season. Perhaps a bit more worrisome is the slight increase in usage of Fed bank facilities, as the tax-related withdrawals could be increasing pressure on some banks again. Based on the 2022 tax season, there will probably be more deposit outflows in next week’s data, so it will be interesting to see if banks need to lean on Fed support facilities to a greater degree to meet withdrawal demands. While the severity of the banking crisis has receded, business loans from banks have contracted for four straight weeks. Some combination of economic headwinds and tightening credit conditions at banks could be driving these declines in business loans. If the deposit outflows continue to cause a restriction in the availability of bank credit, a U.S. recession will be more likely in 2023.
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