With regional bank volatility grabbing headlines, CIO Larry Adam looks at what this activity means for the economy and asset classes.
Over the past two weeks, the regional banking turmoil has reemerged as First Republic Bank failed and was ultimately sold to JP Morgan, shares of other smaller regional banks like PacWest and Western Alliance fell demonstrably, and the merger between TD Bank and First Horizon was surprisingly scuttled. While the S&P 500 has been largely flat over this time period, the KBW Regional Banking Index has plummeted and is now down 61% year-to-date, sitting at a three-year low. Volatility in the regional banking sector is likely to continue into the near future. While headlines of bank failures are unsettling for investors, it’s important to put the recent bout of banking sector volatility into perspective and consider what it means for the economy and asset classes.
Economy – not on the edge quite yet
A healthy banking system is important to the growth of the economy, and, fortunately, the recent turmoil has not yet reached a level that would cause us to significantly change our economic forecasts. Tighter lending standards by the Federal Reserve (Fed) were expected to cool the economy and take the edge off inflationary pressures – which it has. But the recent turmoil in regional banks, caused primarily by poor strategy and risk management, will likely have a bigger impact on business lending than on the consumer.
Impact on lending | As a result of the Fed tightening cycle – 10 consecutive meetings of increasing the Fed funds rate – and rising borrowing costs from credit cards to auto loans, lending standards had already been tightening leading into this recent banking turmoil. In fact, at the end of the first quarter, it was noted that a net 45% of banks had reported tightening lending standards, up from -15% (suggesting easing lending standards) just one year ago. On May 8, updated figures from the Fed’s Senior Loan Officer Survey for 1Q will be released and likely show the trend of further tightening in lending standards. In particular, small/medium-sized banks have likely tightened their lending standards which in turn will weigh on both small business borrowing and investment going forward.