Data as of December 31, 2022. Sources: Bloomberg, Citi Insights. Banks are identified by their tickers. The banks that are represented consist of the 11 stocks in the S&P Regional Bank Index and the five stocks in the S&P Diversified Bank Index.
As the week has plodded (slowly) on, the stock prices of other U.S. regional banks have whipsawed with each incremental piece of news and, as investors parse through the very different balance sheets of each, looking to distinguish those most at risk and those that are better-positioned.
Investors shifted concern across the Atlantic on Wednesday, March 15, with concerns about Credit Suisse permeating the sector. The Swiss lender has been troubled for years due to scandals and financial losses, prompting multiple changes in management. Shares fell from $18 at the start of 2018 to just $3 at the start of 2023. On Wednesday, shares fell 24% and credit default swaps on their bonds surged, and inverted, indicating serious investor concerns or expectations of a default. The decline was deepest midday before the Swiss National Bank said it would provide liquidity to the bank if necessary.
The U.S. government responded swiftly hoping to prevent a pervasive bank run across the country. It consisted of two main actions. First, the Fed, U.S. Treasury, and FDIC jointly announced on Sunday evening that the FDIC would protect all deposits for customers of the failed SIVB and SBNY banks, not just those below the $250,000 threshold. Second, the Fed announced a newly created liquidity facility available to all banks.
The Bank Term Lending Program (BTLP) allows any bank that has access to the regular “discount window”—the standard facility that is typically used for overnight funds to borrow from the Fed but with two critical, distinct features. First, loans can be taken for up to a year. Second, banks can borrow using their typical securities as collateral (Treasuries, mortgage-backed securities, agency securities, etc.) but at the par, or “face,” value of the security. So, even as banks have seen the value of their securities portfolio decline in the rising rate environment, they are now able to borrow above the market value of those securities. This is intended to enable banks to endure deposit outflows without needing to sell securities, as in the case of SIVB.
Financial conditions tighten
The path forward for the economy and the Fed depend significantly on the evolution of broader “financial conditions” and how they affect the economy. With so much focus on the Fed’s main policy rate, the federal funds rate, it is easy to forget that is only an overnight interest rate used by banks to lend to one another.
What really matters is not so much that policy rate but rather how the Fed’s actions are transmitted into more widely used interest rates faced by consumers, homebuyers, and businesses. The term “financial conditions” is meant to encapsulate the overall degree of conditions of financial markets, including interest rates across the yield curve, credit spreads, equity valuations, and currencies. It refers to financial conditions that essentially do the work of the Fed in either tightening or loosening access to liquidity.
Despite a near-record pace of tightening from the Fed in 2022, financial conditions are still only back to long-term historical averages (Figure 2). They have tightened significantly since the start of the Fed’s rate hike campaign in 2022, but only marginally in the wake of the bank crises, and will be important to watch going forward. In particular, should banks recoil from lending or tighten standards—a trend that was already in place before the failure of SVB—financial conditions could tighten even without the Fed doing much more to raise the fed funds rate. If bank lending standards tighten too much, it could cut off access to credit to institutions looking to invest and borrow, increasing recession risks.
Also of note is recent stress in the most liquid parts of the market, including U.S. Treasury bonds and German bunds. Due to a flight to safety on the part of investors, trading volumes have surged and bid/ask spreads have widened. This is a clear sign of stress that, if continued, could put pressure on pricing of related securities, including derivatives and lending products.
Figure 2: Financial conditions tighten, but in line with historic average
Goldman Sachs U.S. financial conditions index (1998–present)