What is Going on with the Banks?

Mar 27, 2023 | Macro Insights, No Bull Economics

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The frailty of the banking system has come front & center over the last couple of weeks as more secondary, unintended symptoms develop from the Fed’s race to raise interest rates.


Higher interest rates are stressing banking sector balance sheets in 3 important ways: first, people & businesses are provided with a very powerful incentive to move their money out of low-yielding bank deposits into higher-yielding T-Bills & treasury bonds; second, higher rates are driving big unrealized losses within the bank’s sizeable bond portfolios (higher rates = lower face values for the bonds); & third, rate hikes are weakening the credit worthiness & demand for consumer loans (including the important mortgage, car loan & credit card businesses).  

Recently published academic research1 shows that bond portfolios represented an estimated 72% of the $24 trillion in aggregated assets owned by 4,800 U.S. banks. Further, marking these bond portfolios to market (adjusting their prices down according to the current interest rates) reveals an estimated 10% loss (or $1.7 trillion). That’s a big number when considering their estimate that the average bank funds 10% of their assets with equity, 63% with insured deposits, and 23% with uninsured debt comprising uninsured deposits & other debt funding. This suggests that the Fed’s rate hikes have nearly wiped out the banking sector’s $2.4 trillion equity cushion.

This is why the Fed has launched its new Bank Term Funding Program (BTFP) which offers loans of up to 1 year to depository institutions pledging U.S. Treasuries, agency debt, and mortgage-backed securities as collateral. Fortunately, these assets will be valued at par even if they are trading at big discounts resulting from the Fed’s rate hikes. It is also notable that there would be no loss at all if the banks were able to hold their bonds to maturity! In any case, we suggest it would have been better not to wreck the banking system with such aggressive rate hikes to begin with. Further, we continue to maintain that it is barbaric to fight higher prices with interest rate hikes intended to cut demand, throw people out of work & initiate a recession rather than commencing on the hard work of lowering prices by increasing supply.     

Source: 1 Monetary Tightening and U.S. Bank Fragility in 2023: Mark-to-Market Losses and Uninsured Depositor Runs? https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4387676

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