Is The Us Banking Crisis Truly Over?

This increased cost is partly because lots of customers have been withdrawing their money and putting it into places where they can make more interest, such as money market funds . It forced banks to borrow more from the Fed to ensure they have enough money, and at rates much higher than they used to be.

This was one of the reasons for the banking collapses in the spring, destabilising them at a time when the value of the debt on their balance sheets had also fallen sharply. This saw more customers at other banks withdrawing deposits for fear that their money wasn't safe either.

In sum,banks saw deposits declining between June 2022 and June 2023 by almost 4% . Together with higher interest rates, this is generally bad news for the banking sector.

You can see the effect on banks' profitability by looking at overallinterest margins (NIMs). These are a measure of what banks receive in interest income miwhat they pay out to depositors and other funders.

banks'interest margins (%)

The ratings agencies have added further pressure. In early August, Fitch downgraded its rating ofgovernment debt to AA+ from AAA. It cited a likely deterioration in the public finances over the next three years and the endless politicking around the debt ceiling, which is the maximum level that the government can borrow.

Sovereign downgrades often reflect problems in the wider economy. This can destabilise banks by making them seem less creditworthy, leading their credit ratings to be downgraded too.

That can make it harder for them to borrow money from the markets or potentially even from the Fed. This can then have knock-on effects in reducing banks' lending capacity, capital buffers for coping with bad debts, overall profitability and share prices .

banks' share prices 2023

Sure enough, a week after the Fitch announcement, Moody's downgraded the credit ratings of tenmid-sized banks, citing growing financial risks and strains that could erode their profitability. It also warned that larger banks including Bank of New York Mellon and State Street were at risk of a future downgrade.

The other major ratings agency, S&P Global Ratings, has since followed suit , while Fitch is threatening to do likewise. Our research suggests bank downgrades are associated with making them riskier and more unstable, particularly when accompanied by a sovereign downgrade.

Having said all that, there are positives forbanks. Both interest rates and bank deposits are at least projected to stabilise in the coming months, which should help the sector.

Despite the overall decline in banks' profitability, bigger banks are reporting improved margins from charging higher interest on loans. Some of these banks also expect a boost from things like increased deal-making later in the year. Signs like those could help to bring more stability across the board.

In Europe, banks have seen reduced deposits andinterest margins in recent years, which helps to explain why Credit Suisse needed to be rescued by fellow Swiss bank UBS in March.

Yet European deposits and profit margins have been recovering in the most recent couple of quarters. At the same time, the European Banking Authority's recent stress tests concluded that large EU banks are robust.

UK banks appear to be in a slightly worse condition than EU banks. They remain resilient on their balance sheets, but their deposits have not recovered to quite the same extent as in Europe. They have also been adjusting down their profit forecasts in anticipation of further rate hikes by the Bank of England.

To strengthen thesector, the regulators are planning to further increase the minimum levels of capital that must be held by largebanks (with assets worth more than US$100 billion).

These plans to increase banks' capacity to absorb losses are encouraging, though will take more than four years to fully implement. The Basel II international banking rules were introduced to a similar end in 2004, but were not implemented in time to prevent the global financial crisis.

For the moment, thebanking system remains vulnerable both to shocks within the financial system and more general calamities. It will still be a few months before we can say with confidence that the worst is over.

George Kladakis is Lecturer in Financial Services, Edinburgh Napier University and Alexandros Skouralis is Research Assistant, Bayes Business School, City, University of London

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