Why are US regional banks doomed to fail?

Banking authorities have been pushed by market volatility in recent weeks to do things they didn't want to do, such as allowing the largest US bank to grow even larger. Their hand may be forced once more.

Consider the Federal Deposit Insurance Corporation (FDIC), one of the primary banking regulators. Chairman Martin Gruenberg stated in a December 2021 statement that the sale of several insolvent banks to the likes of JPMorgan Chase & Co (JPM.N) during the 2008 financial crisis had arguably "increased long-term financial stability risk."

This made authorities leery of further concentration. According to two persons familiar with the case, when the FDIC took over Silicon Valley Bank in March after a run on the lender spurred a broader deposit flight to safety, some of the top US banks originally had the notion that their offers would be rejected.

According to one of the sources, they were not allowed inside the data room until it was too late to submit a proposal.

However, when First Republic Bank failed a month and a half later, the FDIC was forced to sell it to JPMorgan since it was the least expensive choice for the deposit insurance fund.

According to an FDIC representative, the government did neither exclude or allow so-called global systemically significant banks (G-SIBs) to bid on Silicon Valley Bank. Because of the rapidity with which the fall occurred, it took the agency some time to set up a data room, delaying the procedure. According to the spokesperson, the G-SIBs elected not to bid, showing a lack of interest in the asset.

Gruenberg did not respond.

A regional banking sector that is dysfunctional is extremely problematic. These banks lend to large segments of the US economy, but deposit flight has prompted them to curtail lending. Three US banks have failed, and the shares of others have suffered as a result, with the KBW Regional Banking Index (.KRX) down 30% since March 8.

An unclear economic future as a result of tight monetary policy, as well as other factors such as decreasing commercial real estate values and the US debt ceiling dispute, are exacerbating the situation. Continued stress on these banks may cause the economy to enter a recession.

Despite the fact that things have significantly calmed down since March, investors have hesitated to declare the crisis over.

As a result, regulators, bankers, and other experts are speculating on other moves Washington could take to end the crisis. These suggestions range from hastening the approval of bank mergers to strengthening deposit guarantees and scrutinising investors who bet on stock market declines.

However, those choices either encourage things that regulators do not want, such as the formation of larger banks or irresponsible behaviour, or are moves that have not succeeded in the past, such as short-selling restrictions, according to banking experts. Some would also necessitate legislative approval, which would be difficult in a divided Congress.

As a result, regulators are left with instruments that treat symptoms but have undesired side effects and do not deliver a cure.

They have given banks with lifelines, such as enough cash to cover deposit withdrawals. However, there is currently a confidence issue, with some investors questioning the ability of some of these lenders to generate money in the long run.

As a result, when one bank collapses, another comes to the market's attention, creating a vicious cycle and increasing pressure on regulators to intervene once more.

Treasury Secretary Janet Yellen stated on Saturday that nearly all banks have adequate liquidity, but earnings pressures may force some midsize bank mergers.

“That’s something I think the regulators will be open to, if it occurs,” she said.

By fLEXI tEAM