Why the struggles of mid-sized US banks could be bad news for the Main Street economy
Households and businesses may find it harder to get loans from regional banks as people pull deposits from those lenders.
Around $1 trillion in deposits have been pulled from the "most vulnerable US banks" since rate hikes started last year, with half of that coming out since SVB collapsed.
"Given what's happened, I would expect banks to have higher requirements, be more strict on their loans," a source said.
Silicon Valley Bank's spectacular crash threw the spotlight on deposits flowing out of regional banks, and those shrinking money pools stand to make it even more difficult for American households and businesses to get loans.
Around $1 trillion in deposits have been withdrawn from the "most vulnerable US banks" since the Federal Reserve began raising interest rates in March 2022, JPMorgan said in a research note published late last week. Half of that amount came out after SVB blew up about two weeks ago, it said.
Deposits flying out of banks can create a credit crunch that puts the US economy at risk of recession, a potential event that Federal Reserve Chairman Jerome Powell flagged last week when delivering the central bank's ninth consecutive increase in interest rates, to 4.75%-5%, from zero last year.
"The uncertainty generated by deposit movements could cause banks to become more cautious on lending. This risk is heightened by the fact that mid- and small-size banks play a disproportionally large role in US bank lending," wrote JPMorgan's global markets strategy team led by Nikolaos Panigirtzoglou.
Speaking with Insider, Alexander Yokum, an equity research analyst who covers regional banks at CFRA Research, said: "Given what's happened, I would expect banks to have higher requirements, be more strict on their loans, and potentially charge more for a similar risk profile."
SVB and Signature Bank customers, worried about the lenders' financial stability and the safety of their uninsured deposits, yanked billions of dollars from their accounts, igniting a rush for deposits at other small and mid-sized banks. Depositors over the past two weeks have pushed $286 billion into money market funds, which JPMorgan points out are both perceived as safer than uninsured deposits and offer better yields.
"The greatest vulnerabilities with respect to credit creation going forward lie with non-mortgage bank lending to households and mortgage bank lending for non-financial non-corporate businesses," JPMorgan said.
Meaning risks are growing that households seeking personal loans, credit cards, or other types of loans, and local businesses that need credit to build up inventory or pay employees will have higher hurdles to borrow from their bank.
"[You] have deposits running away from banks and going into money funds and you have bank management thinking, 'Okay, how do we survive this now? Well, we probably don't do it by lending,'" Ian Shepherdson, chief economist at Pantheon Macroeconomics, said in an CNBC interview on Monday.
A disproportionately large role
$120 billion in deposits were pulled from small banks in the week ended March 15, leaving a tally of $5.46 trillion, Federal Reserve data released Friday showed.
Regional banks are "very important" to the financial system, CFRA's Yokum said.
"I don't think it's good to just have a couple of mega-banks. Regional banks can potentially give better service, more customized products, potentially higher deposit rates," he said.
Some hefty figures illustrate the "disproportionately large" role small banks hold in lending in the US. JPMorgan said that of the $5 trillion stock of commercial loans extended by domestic banks, 43% was granted by 300 listed banks considered mid-sized by assets and 16% by small and unlisted US banks.
Economists at Goldman Sachs found that lenders with less than $250 billion in assets account for about 45% of consumer lending.
"In a modern banking-driven developed economy, when the flow of credit is squeezed, bad things happen to growth. So, I'm getting really nervous now that an economy that I thought was going to dodge recession - just - is now at much greater risk of falling into one," said Shepherdson.
The Fed's rate hikes and the "failure of bank deposit rates to respond to this rise," and the central bank "draining reserves" from the banking system through quantitative tightening were two key drivers of deposits outflows, said JPMorgan.
The third was the FDIC's $250,000 insurance cap on accounts, it said, leaving $7 trillion of bank deposits uninsured before the SVB crisis.
For its part, Goldman Sachs cut its fourth-quarter US growth forecast to 1.2% from 1.5% stemming from stress in the banking system. Lending standards may tighten "to a degree that's greater than during the dot-com crisis, but less than during the financial crisis or the height of the pandemic," Goldman said in a note.
After SVB's implosion, Yokum said he would expect a more than a 1% drop in deposits at the average regional bank. "Anything … above 5%, or even 4%, I'm definitely going to be looking twice," he said.
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