US economy could be slowed by a broad credit crunch caused by recent banking turmoil, according to the Federal Reserve. On Monday, the Fed issued two publications cautioning that the failures of Silicon Valley Bank and Signature Bank in March, along with First Republic’s recent collapse, may result in reduced lending and lower asset prices. Despite decisive actions taken by regulators and officials to address these crises, concerns about economic prospects, credit quality, and funding liquidity may compel banks and other financial institutions to continue contracting credit supply to the economy.
With the White House and Congress at odds over raising the government’s borrowing limit, the Federal Reserve’s financial stability report, released twice a year, revealed fears of a credit contraction. Treasury secretary Janet Yellen warned that failure to reach a deal by early June would be a “catastrophe” for the economy and markets.
In addition, the Fed’s survey of market professionals and academics found that the share who ranked banking sector stress as the top stability risk has quadrupled since the autumn, now ranking on par with inflation and US-China tensions. There is also an increase in real estate concerns in the commercial and residential sectors.
The Fed’s quarterly Senior Loan Officer Opinion Survey revealed that banks expect to tighten lending standards in the rest of 2023 due to concerns about a recession and deposit withdrawals in the wake of SVB’s collapse.
In addition to the aforementioned concerns, the Fed’s financial stability report cautions that a credit crunch may result in lower earnings and increased defaults for businesses. Such an event could also decrease investor willingness to take risks, resulting in substantial decreases in asset valuations. Nonetheless, the Federal Reserve points out that shocks are less probable to spill over into the financial system through households since household borrowing is relatively modest compared to income levels, and individuals with higher credit scores hold most of the household debt.
Despite the warning of a possible credit crunch, the Fed said most banks seemed able to handle tighter monetary policy. According to the fourth quarter of 2022, global systemically important banks, particularly those in the US, were well-capitalised.
The recent banking turmoil has raised concerns for the US economy, with fears of a credit contraction and a possible debt default looming. The Fed has warned that this could lead to a decline in profits, rising defaults among businesses, and significant declines in asset prices. While most banks are resilient to potential strains from higher interest rates, the Fed’s twice-yearly financial stability report and other publications highlight the need for ongoing vigilance and attention to these issues.