How the banking crisis could affect the economy

Image: Aïda Amer/Axios

The US banking system appears to have stabilized for now after the government took extraordinary measures to avert total disaster following the collapse of the Silicon Valley bank.

Yes but: Wall Street economists and the Fed are increasingly expecting the fallout from this collapse to linger in the coming months as regional and local banks ease lending.

Why it matters: The economy runs on credit and loans. Should that activity slow or halt altogether, there would be domino effects on hiring, spending and more — particularly if banks, which are the most active lenders to small and medium-sized businesses, are forced to pull out.

The scenery: Before the banking turmoil of the last few weeks began, banks were already tightening their lending.

• A quarterly Fed survey of loan officers showed that a net 40% reported tighter corporate lending standards in the final quarter of last year. Without taking into account the outbreak of the pandemic, this is the highest proportion since 2009.

The big picture: Banks face the risk of a two-pronged problem. Unfortunately, these are assets and liabilities.

• That means credit conditions could tighten as people pull out bank deposits (which are liabilities) and due to further losses in loans and securities (assets).

Game Status: Total bank deposits have been falling for nearly a year — from $18.1 trillion last April to $17.6 trillion last week — as Americans shift money from low-interest-paying bank accounts to higher-yielding savings vehicles like Treasury bills and mutual funds .

• If this accelerates amid fears for deposit safety, it would result in affected banks shrinking the asset side of their balance sheets, mainly by lending less.
• A shift away from smaller banks to larger ones keeps the total number stable but would still limit the availability of credit for smaller businesses and real estate investors who rely on community banks.

What you say: “Banks could basically say, ‘We can’t lend as much,’ because they’re worried they won’t have enough liquidity to pay off deposits,” said Kathy Bostjancic, chief economist at Nationwide.

• Banks may also fear that regulators and supervisors will scrutinize them even more in the wake of the banking crisis, making them reluctant to expand their balance sheets.

Between the lines: Businesses would have a harder time accessing the money needed to hire more employees or spend on new equipment needed to expand the business. Consumers could also have a harder time getting a loan.

• On a large enough scale, this would spill over into the labor market and consumer demand, and in turn help moderate gains.

The bottom line: However, no one knows how severe the impending credit crunch will be and to what extent it will affect economic activity.

• Economists at Goldman Sachs say tighter lending would weigh on US growth by up to half a percentage point this year.
• However, economists there warn that the strain could be greater, “particularly in the event of further bank failures, significant regulatory changes or sustained outflows of deposits that increase the sensitivity of lending to bank capital.”