Is the US Banking Crisis Over? Assessing the Current State of the Banking Sector
The US banking crisis earlier this year triggered concerns about the stability of the global banking system. Several mid-sized US banks, including Silicon Valley Bank, Silvergate, and Signature, experienced failures in quick succession, causing a decline in bank share prices worldwide. Thankfully, the Federal Reserve intervened by providing significant amounts of cash to the failed banks and creating a lending facility for struggling institutions, preventing immediate contagion. However, the question remains: is the crisis truly over?
One of the ongoing challenges facing US banks is the tight margins and dwindling deposits. Central banks have been increasing interest rates to combat sustained inflation, with the Fed raising its key interest rate to the highest level in 20 years. Such rapid changes can be detrimental to banks, especially in the context of the U-shaped movement in rates since the global financial crisis. Raising rates reduces the value of banks’ assets, increases borrowing costs, limits profitability, and heightens vulnerability to adverse events. Additionally, banks have had to grapple with low loan growth and high deposit costs, leading to a decline in deposits of almost 4% between June 2022 and June 2023. This, coupled with higher interest rates, presents a challenging environment for the banking sector.
The credit rating downgrades have further exacerbated the situation. Rating agencies like Fitch and Moody’s have downgraded both US government debt and the credit ratings of several mid-sized banks. Sovereign downgrades often reflect wider economic issues, making banks appear less creditworthy and impacting their access to borrowing. The knock-on effects include reduced lending capacity, weaker capital buffers, decreased profitability, and declining share prices. Although there are positives on the horizon, such as projected stabilization of interest rates and bank deposits, the impact of these downgrades continues to weigh on the banking industry.
It is worth noting that Europe’s banks have faced similar challenges, with reduced deposits and net interest margins in recent years. The rescue of Credit Suisse by UBS showcases the difficulties European banks have encountered. However, the most recent quarters have shown signs of recovery, and large EU banks have passed stress tests conducted by the European Banking Authority. UK banks, on the other hand, lag slightly behind their EU counterparts in terms of deposit recovery and have adjusted profit forecasts in anticipation of further rate hikes by the Bank of England.
In response to these challenges, regulators are planning to increase the minimum levels of capital that large US banks must hold. While these plans are encouraging, their full implementation will take more than four years. The Basel II international banking rules introduced in 2004 aimed to strengthen the banking sector but were not implemented in time to prevent the global financial crisis. Regulatory intervention is crucial to fortify the US banking system against future shocks and calamities.
In conclusion, while some positive signs can be observed in the US banking sector, it remains vulnerable to both internal and external risks. It will take several more months before the situation can be confidently declared as stabilized. As traders return to the markets after their summer breaks, the coming months will be critical in determining the trajectory of the US banking crisis.
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