The banking industry’s stress is being closely monitored for the possibility of a credit crunch, a U.S. Federal Reserve policymaker warned on March 26, while a European Central Bank official similarly hinted at possible lending tightening.
Regulators throughout the world are on high alert for the consequences of recent financial instability, including the failures of Silicon Valley Bank and Signature Bank in the United States, as well as the rescue takeover of Credit Suisse a week ago.
The week ended with financial market stress. The euro plummeted against the dollar, eurozone government bond yields decreased, and the cost of safeguarding against bank defaults increased, despite officials’ assurances. In its latest effort to reassure investors, the US Treasury said on March 24 that the Financial Stability Oversight Council expected the US banking system to be sound and resilient. What they really don’t know is how much these stresses in banking are causing a widespread credit crunch. This would then slow the economy. Minneapolis Fed President Neel Kashkari indicated on CBS’s Meet the Nation on March 26 that they are keeping a close eye on this.
According to Kashkari, one of the Fed policymakers who has been the most hawkish in favoring higher interest rates to combat inflation, it unquestionably puts them closer.
He stated that it was too early to predict the impact of bank stress on the economy, and thus too early to anticipate how it would influence the Federal Open Market Committee’s next interest rate decision. Meanwhile, in Europe, the ECB’s vice president, Luis de Guindos, believes that recent financial sector upheaval may result in weaker GDP and inflation rates.
Further, he told Business Post, these will, in their opinion, lead to further tightening of credit standards in the eurozone, possibly resulting in less growth and inflation in the economy.
With the rescue buyout of Credit Suisse by Zurich-based rival UBS, Germany’s Deutsche Bank stepped into the investor limelight. On March 24, shares in Germany’s largest bank plummeted 8.5%, while the cost of insuring its debts against failure rose substantially and the index of leading European bank shares plunged.
The abrupt increase in bank tensions has spurred speculation about whether major central banks would continue to pursue aggressive interest rate hikes to try to reduce inflation, as well as when rates may begin to decline. Erik Nielsen, group chief economics counsel at UniCredit in London, believes central banks should not divorce monetary policy from financial stability at a time when risks of a broad financial crisis are high.
Nielsen said in a note on March 26 that major central banks, including the Fed and the ECB, should issue a coordinated statement saying that any additional rate hikes are off the table at least until financial markets stabilise.
The Federal Reserve hiked interest rates by a quarter point recently but left the door open to more rises until it was clear how bank lending practises would alter in the aftermath of the recent failures of SVB and New York-based Signature Bank. According to Kashkari, there are some troubling signals, but on the plus side, deposit outflows appear to have eased. Smaller and more regional banks are regaining trust.
Volatility in banking equities on both sides of the Atlantic persists despite efforts by politicians, central banks, as well as regulators to discard fears.
Kashkari noted that during the past two weeks, the capital markets have been largely shuttered. Because the financial markets are closed and both lenders and borrowers are still concerned, it is likely that the economy will suffer further. He further added that it is too soon to make predictions for the upcoming FOMC meeting.