"US Small Banks Fail One After Another... Similar to 1980s Crisis"

Although it has been a month and a half since the banking crisis triggered by the bankruptcy of Silicon Valley Bank (SVB) in the United States, warnings about small and medium-sized regional banks remain. This is because the steep interest rate hike phase is increasing the risk of credit tightening. There are even warnings that a banking insolvency crisis comparable in scale to the chain collapse of U.S. savings and loan associations that began in 1989 could engulf the global financial market.

On the 23rd (local time), The Wall Street Journal (WSJ) reported that the current financial market situation resembles the troubled savings and loan crisis that began in the late 1980s, which caused hundreds of bank failures over several years and weakened the U.S. economy. Just as hundreds of savings and loan associations collapsed or required bailouts over several years amid rapid interest rate hikes more than 40 years ago, the crisis among small and medium-sized regional banks may continue at a slow pace.

WSJ pointed out that although liquidity has stabilized as authorities’ support and banks with strong funding capacity have taken the lead, the risk factors facing small and medium-sized regional banks have not been resolved.

The biggest risk factor facing small and medium-sized regional banks is massive deposit outflows. As banking sector risks spread, thousands of billions of dollars in deposits from small and medium-sized banks are moving to money market funds (MMFs), which have relatively low credit risk and good liquidity and profitability. Long-standing customers of small and medium-sized banks are transferring funds to MMFs, and WSJ pointed out that slow and steady deposit erosion will continue.

Comparing the asset-liability structures of 25 large and small banks reveals this risk clearly. For large banks, average deposits decreased moderately from 5.56% year-over-year on March 1 (shortly after the SVB bankruptcy) to 4.2% on March 29, but small and medium-sized banks saw a sharp drop from 15.15% to 10.18%. This reflects the fact that the SVB bankruptcy mainly affected small and medium-sized banks. Such deposit outflows lead to increased funding costs for small and medium-sized banks. This is why warnings continue that the steep interest rate hike phase raises the risk of credit tightening and increases the likelihood of a second or third SVB-like crisis.

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On the 21st, international credit rating agency Moody’s downgraded the credit ratings of 11 small and medium-sized regional banks in the U.S., including Western Alliance Bancorp, U.S. Bancorp, Zions Bancorporation, and Bank of Hawaii, reflecting these risks. Western Alliance Bancorp, one of the hardest-hit banks by the SVB crisis, saw its credit rating lowered by two notches. More than half of this bank’s deposits were uninsured as of the end of 2022, and 11% of deposits were withdrawn in the first quarter of this year alone.

The recently downgraded U.S. Bank was criticized for its low capital ratio and large unrealized (book) losses. Earlier, U.S. banks invested heavily in U.S. Treasury securities, considered safe assets, as deposits surged amid abundant liquidity during the COVID-19 pandemic. However, rising interest rates caused U.S. Treasury prices to fall, significantly expanding unrealized losses. There are concerns that some banks might follow SVB’s path by selling Treasury securities at a loss to raise funds for deposit returns. Zions Bancorporation also faced issues with significant unrealized losses in its securities portfolio and deteriorating capital.

Moody’s analyzed, "Banks are facing increased burdens in managing assets and liabilities and are under pressure on profitability," adding, "The recent banking crisis has raised questions about whether banks need to reassess the stability of deposits and their operational methods."

[Image source=AFP Yonhap News]

Deposit outflows from small and medium-sized banks leading to reduced lending tighten financial conditions further and increase economic uncertainty. The largest U.S. investment bank, Goldman Sachs, estimates that every 2% decrease in bank lending results in a 10% decline in bank profitability. In fact, a recent survey conducted last month among small businesses affiliated with the National Federation of Independent Business (NFIB) reported that more U.S. small businesses are experiencing difficulties obtaining loans due to credit tightening following the SVB bankruptcy. The proportion of small businesses responding that financing was more difficult compared to the previous month (before the SVB crisis) was 9%, the highest since December 2012.

Goldman Sachs also forecasted that this credit tightening could reduce economic growth by 0.3 to 0.5 percentage points this year as it restricts corporate activities. Credit tightening also increases the long-term risk of corporate bankruptcies. Robert Kaplan, former president of the Federal Reserve Bank of Dallas, said, "Small and medium-sized banks across the U.S. are simultaneously freezing or reducing their loan-to-deposit ratios at current levels," and predicted, "Loan extensions to companies may not be made by the end of the year, or loan terms may be renegotiated."