While Silicon Valley Bank and Signature Bank’s failures may
seem like old news, concerns about deeper problems in the banking sector that
could harm the overall economy and S&P 500 are still alive.
Despite the growth in the sector’s stocks following last week’s
Federal Reserve decision, experts warn that one move will not solve all the
underlying problems, so caution should be exercised.
One of the biggest concerns lies in the commercial real
estate sector, where small banks hold 70% of the debt, much of which is close
to default, a challenge that will not be resolved quickly.
Moreover, despite some improvement in bond prices,
unrealized losses on financial institutions’ investment securities remain high:
about $513 billion in the second quarter, up from $750 billion in 2023.
But is there cause for concern?
First, these losses only become real if banks are forced to
sell their assets. The good news is that, with the Fed’s pivot to lower
interest rates, things should improve significantly as bond prices rise.
However, in practice, even after the Fed
decided to cut interest rates by 50 basis points, yields on longer-term
Treasury bonds, like the 10-, 20-, and 30-year bonds, are still elevated.
As for the potential fallout from the commercial real estate
sector, most banks have set aside billions as a cushion against potential
borrower defaults. Those facing difficulties also have options.
Specifically, they can refinance their loans or negotiate
better repayment terms. Lower rates are expected to make payments more bearable
for borrowers with variable-rate loans.
What about the Basel III changes?
Recently, bank stocks have been pressured by the prospect of
tighter capital requirements, which banks must maintain to protect against
credit, operational, and market risks.
The underlying idea is to avoid situations like the
one with Silicon Valley Bank, where news of liquidity problems triggered
panic among depositors and eventually led to the bank’s failure.
The problem is that, according to the banks themselves, this
initiative could cut bank profits and make it more difficult for individuals
and companies to obtain loans, which could harm the economy.
On the bright side, due to growing industry discontent and
FDIC resistance, the new draft will only increase capital for large banks by 9%
instead of the 20% previously proposed.
The bottom line?
Although the industry faces some challenges, the decline in
rates should improve the financial health of many institutions, provided there
are no unforeseen events.
