What’s next for the U.S. and European banking sectors?

From tranquility to turmoil

For around a year since the Fed began to hike rates in early 2022, all was quiet on the financial front, with the focus of developed-market central banks placed firmly on reining in above-target inflation. Things changed abruptly in early March with the collapses of SVB and Signature Bank and Credit Suisse’s ignominious takeover by fellow Swiss banking giant UBS. Shares and deposits at other banks have since taken a hit amid fears over which institutions are next in line to fail.

The difficulties of higher rates

Central Bank monetary tightening provides the opportunity for commercial banks to widen the spread between the interest rates on deposits and loans, which can boost profits. However, rising interest rates are no panacea, and entail risks in the form of large unrealized losses on bold portfolios, higher rates of unperforming loans, weakness in the property sector, higher debt financing costs and depositor outflows. SVB’s collapse is a case in point; the Bank was particularly at risk due to its unusually large bond portfolio and flighty customers—many of which were tech firms with deposits above the USD 250,000 Federal insurance limit.

More to come

In a survey we conducted in mid-March, most analysts expected further financial trouble for U.S. and European banks over the next 12 months. However, the consensus was that recent events did not herald the start of another global financial crisis. The authorities have taken prompt action to head off market worries; The U.S. government will guarantee all deposits—both insured and uninsured—at SVB and Signature Bank, and major central banks announced they stood ready to provide extra liquidity to the banking sector.

The hit to growth

In general, our panelists expect the impact of recent banking turmoil on the U.S. and European economies to be mild. Financial conditions are likely to tighten somewhat due to skittish investors and more cautious lending practices by banks, although this could be partially offset by smaller-than-previously-anticipated rate hikes. However, if—against expectations—a systemic financial crisis occurs, all bets would be off.

Insights From Our Analyst Network?

On European banks,?Dennis Huchzermeier, economist at the Handelsblatt Research Institute, said:

“The capitalization of the global and European banking sector is very good and the problems of Credit Suisse were foreseeable for months if not for years.”

On the U.S. economy,?analysts at ING?said:

“The stresses created by the SVB fallout will only make banks more nervous about who they lend to, how much they lend and at what interest rate. […] This could lead to a snowball effect of risk aversion and tightening of lending standards that hampers credit flows [and] weighs on the economy.”

Written by FocusEconomics economists Massimo Bassetti, Ph.D and Oliver Reynolds