News in Charts: Banking crises – what to watch out for

The US could still experience a systemic banking crisis this year, although Fathom’s central view is that this is unlikely. This note lays out the three C’s to watch out for as potential warning flags for a systemic crisis: contagion, credit losses and complacency.

Contagion

One way of identifying contagion is through deposit outflows. If individuals lose confidence in a bank, they will withdraw their deposits rapidly — in other words, there will be a run on that bank. This is what happened at SVB. In a systemic crisis, there is a run on many or all banks, as happened during the GFC of 2008/09. You can see some evidence this time around of deposit outflows spreading to other smaller banks following SVB’s collapse (the chart above shows that deposits dropped by around $200bn), but there is limited evidence so far of contagion to the larger US banks, where roughly two thirds of all deposits reside; the trend of falling deposits at those institutions has been in place for some time and appears to be more closely related to the increase in money market funds and a search for higher yields on savings.

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Credit losses

If one company defaults on a loan then the company that lent that money might not be able to repay its own creditors. This form of contagion can amplify the effect of credit losses from monetary policy tightening. Fear of loan delinquency caused interbank lending to dry up and ultimately led to a credit crunch during the GFC. To date, we have not seen a rapid rise in either corporate failures or loan defaults (although the delinquency rate on consumer loans has started to rise gradually).

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But monetary policy acts with long and variable lags, and so the possibility of defaults increasing further down the line cannot be ruled out. Indeed, as the chart below shows, there is a clear relationship between the rate of corporate failures and changes in the policy rate. This is to be expected — the reason that monetary tightening is expected to rein in inflation is that it slows aggregate demand. Corporate failures, though undesirable, are part of the transmission mechanism of monetary policy.

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For this reason, Fathom maintains that the US economy is likely to enter a recession later this year and that there is likely to be a rise in loan defaults and business failures. If this proves correct, banks could suffer significant losses and it is entirely possible that the US banking system will find itself under a second round of pressure, with talk of a systemic banking crisis rearing its head once more. Again, this is not Fathom’s central case, but one that Fathom will monitor closely.

Complacency

If the credit cycle does turn negative and banking losses rise alarmingly, regulators have many tools at their disposal. There is, however, a risk that could arise from complacency. Although there have been some criticisms about the risks of moral hazard, policymakers have been generally praised for their rapid handling of the collapses of SVB and Signature Bank, and the forced sale of Credit Suisse.
A recent paper and dataset produced by the US’s National Bureau of Economic Research help to contextualise the magnitude of policymakers’ interventions. Looking at responses to almost 900 historical banking crises, the authors conclude that only 6.5% of crises have elicited the same type of response (i.e., account guarantees and emergency lending interventions), as we have seen this year. More than 70% of those interventions took place in and around a systemic crisis. In other words, policymakers are reacting as you might expect them to in a world of systemic vulnerability.
In SVB, Signature Bank and Credit Suisse, the battle against inflation has claimed its (perhaps unexpected) first casualties, but these may not be the last: it remains to be seen what else the sustained pressure of high interest rates may force into the light.

The views expressed in this article are the views of the author, not necessarily those of Refinitiv Lipper or LSEG.

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