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.
Lifted by better-than-expected earnings from four large banks and generally supportive forward guidance, this week large banks outperformed the S&P 500 for the first time since the crisis began. Some smaller bank earnings start in the coming week, and those releases may provide additional color beyond some of the less optimistic data presented here. Despite the better performance this week, the KBW Bank index is down almost 18% year-to-date. As measured by the KBW Regional Bank index, smaller bank stocks declined nearly 22% 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 due to better earnings data and are close to the lowest 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, 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, a positive development was a reduction in the discount window and BTFP usage. In addition, the credit used by the bridge banks fell as the FDIC made some headway in winding down the failed banks. Overall, the reduction in Fed bank lending across all four available facilities indicates that the impact of the banking crisis is receding.
Bank deposit outflows stopped, and deposits grew for the first time since the beginning of the crisis 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 lost deposits.
Small banks saw another $28.2 deposit inflow this week. Remarkably, there was no downward revision to small deposits for the previous week.
Cash has continued 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 smaller 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 over the previous two weeks when lending to that segment fell the most on record. CRE lending from small banks was fractionally 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 small banks over the past three weeks. Again this is a divergence between large and small banks, as C&I loans by large banks grew modestly during the same period.
In summary, the U.S. banking system continued healing from the extremes of the crisis. On a particularly positive note, small and large banks had deposit inflows. While the severity of the banking crisis is receding, the real economic impacts can now be seen. Loans from smaller banks have contracted for three straight weeks, but the decline this week was notably smaller. The divergence between large and small banks is a critical component of this crisis, as large banks have seen net deposit growth instead of shrinkage at small banks. The future availability of commercial real estate loans seems likely to be impacted, with smaller banks historically providing the majority of these loans. Significantly, lending should recover if deposits return to the smaller banks, and perhaps a credit crunch can be avoided. All other things being equal, a restriction in the availability of bank credit makes a U.S. recession more likely in 2023.
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