Weekly Buzz: Another bank bites the dust

05 May 2023

🪣 What’s the moral hazard of bailing out banks? 

First Republic Bank – a regional US lender – became the latest victim of the banking sector’s crisis of confidence. Like other mid-sized US banks, First Republic experienced massive deposit outflows in the wake of the collapse of Silicon Valley Bank (SVB) as clients fled for safety in larger institutions. That kicked off worries about its stability and culminated in a consortium of banks launching a US$30 billion rescue package for the bank.

By the time April rolled around, First Republic’s first quarter results revealed that depositors had pulled more than US$100 billion from the bank. That proved to be the final nail in the coffin. Less than a week later, US regulators seized the bank’s assets – a combination of loans, securities and deposits worth about US$295 billion – and sold them to JPMorgan Chase. 

Is this the “the end” of bank failures? 

Regulators’ quick action has helped restore confidence in the banking system, but it’s also  reinforced concerns about moral hazard (more on this below in Jargon Buster) in the sector. Now, the big question is if we are “getting near the end” of  the banking sector’s woes, as JPMorgan’s CEO Jamie Dimon seems to think. 

While some analysts agree, others remain sceptical as they see potential for more instability in the sector. In fact, earlier this week, concerns about the health of the banking sector contributed to a slide in the shares of US regional banks. 

🏦 The Fed bumps up rates again but signals policy pause

On 3 May, the US Federal Reserve delivered another 25 basis point increase in interest rates, in line with the market consensus. Importantly, the Fed’s latest statement dropped language saying it anticipated further rate hikes would be needed – suggesting that it’s likely to put its hiking cycle on pause. 

That doesn’t mean further increases are off the table, as inflation remains high and the labour market is still in the process of cooling. After the decision, Fed chair Jerome Powell said that the committee is “prepared to do more” if necessary. What about rate cuts? Powell stressed that those are unlikely this year – in contrast with market expectations of cuts starting in the second half of 2023.

🎓 Jargon buster: Moral hazard 

Moral hazard refers to a situation when one party – like a bank, for example – is incentivised to take more risk or ignore the need to guard against it because they are protected from the consequences. 

Take the case of SVB. Incentivised by the prospect of high profits, the bank went all in on the risky tech and startup sector, a decision which eventually led to its collapse. Instead of allowing SVB deposits to be completely wiped out, bank regulators swooped in to guarantee them, despite most being uninsured by the Federal Deposit Insurance Corporation (FDIC). 

Here, the moral hazard is that banks may view regulators’ willingness to bail them out as a sign that they can take on more risk. 

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