The Federal Reserve has warned that the recent banking turmoil could fuel a broad-based credit crunch that risks slowing the US economy, as lenders told the central bank they plan to tighten lending standards amid concerns about loan losses and the flight of deposits.
Two separate Fed releases on Monday highlighted growing concerns over the collapses of Silicon Valley Bank and Signature Bank in March and last week’s bankruptcy of First Republic it will lead to loan reductions and drive down asset prices.
The US central bank said in its semiannual financial stability report that despite “decisive actions” by regulators and officials to address recent regional banking crises, concerns about the “economic outlook, the quality of credit and funding liquidity” could lead “banks and other financial institutions to further reduce the supply of credit to the economy”.
THE Powered he added: “A sharp contraction in the availability of credit would increase the cost of funding for businesses and households, potentially causing a slowdown in economic activity”.
The possibility of a credit crunch was cited among the major current risks to the financial system, rather than the Fed’s most likely scenario. But it reflected anxiety about the macroeconomic impact of one of the most tumultuous months in US finance since the financial crisis global 2008.
“The credit crunch, or at least the credit crunch, is starting,” Austan Goolsbee, president of the Federal Reserve Bank of Chicago, told Yahoo Finance on Monday. “I think you have to say that recession is a possibility.”
Fears of a credit crunch come as a possible US debt default looms with the White House and Congress at an impasse over raising the government’s $31.4 trillion loan limit. An agreement must be reached by early June to avoid what Treasury Secretary Janet Yellen warned would be a “catastrophe” for the economy and the markets.
As part of its stability report, the Fed interviewed market professionals and academics. The share that ranked banking sector stress as the top risk to stability has quadrupled since the autumn, now on par with inflation and US-China tensions. Concerns about commercial and residential real estate are also rising rapidly, the survey found.
The Fed also released the results of its quarterly opinion poll of senior loan officers on Monday, which found banks plan to tighten lending standards in the remainder of 2023. Bank officials underscored concerns about a recession and the withdrawal of deposits following the collapse of SVB.
The biggest banks, those with at least $250 billion in assets, attributed the potential slowdown in lending to an uncertain economic outlook, according to Lending Survey data.
“Compared to larger, mid-sized banks [with between $50bn and $250bn in assets] and other banks more frequently cited concerns about their liquidity positions, deposit outflows and funding costs as reasons to tighten,” the Fed said of the survey.
In an effort to keep depositors, some banks have had to do this offer better yields on savings accounts, weighing on profit margins. Mid-sized banks, which faced the largest deposit outflowshe also signaled fears of tougher regulations and potential changes to accounting rules.
In terms of how a possible credit crunch could play out more broadly, the Fed’s financial stability report says there is a danger of falling profits and rising delinquencies among businesses. “Furthermore, an associated reduction in investors’ appetite for risk could lead to a significant decline in asset prices.”
The Fed also warned of weaknesses in the commercial real estate sector, saying “the magnitude of a correction in property values could be substantial and therefore could lead to credit losses by CRE debt holders.”
The central bank said it would also monitor developments in commercial home loans more closely and expand “screening procedures” for banks with higher concentrations in the sector.
On the less worrying side, the Fed said that “shocks are less likely to propagate to the financial system via the household sector because household debt is moderate relative to income and most household debt is owed to those who have a higher credit score”.
Though it warned that lending could suffer, the Fed said most banks appeared capable of handling tighter monetary policy.
“Despite the banking stress in March, high capital levels and moderate interest rate risk exposures mean that the vast majority of banks are resilient to potential stress from higher interest rates. As of the fourth quarter of 2022, banks overall were well capitalized, especially global systemically important US banks,” he said.
Additional reporting by Stephen Gandel in New York and Colby Smith in Washington
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