The banking crisis is not over. But how bad would it be?

Bank shares sold off on Wall Street this week following the government seizure and subsequent sale of First Republic Bank to JPMorgan. It was the second largest bank failure in US history and the third failure of a medium-sized lender in two months.

While many thought First Republic sales were “who’s next?” conversation, investors are clearly focusing on the remaining players deemed most vulnerable,” analysts at UBS wrote in a note to clients.

The bigger concern is that a bank failure could raise doubts about relatively healthy banks, creating a financial contagion that could affect the wider economy. Avoiding that scenario led the US to impose tighter restrictions on major banks after the financial crisis 15 years ago.

It’s hard to ignore the feeling of unease in banking right now, though there’s no need to worry if your money is in a bank insured by the Federal Deposit Insurance Corp. and you have less than $250,000 there, which covers most accounts.

Bankers and regulators have tried to reassure investors that the worst of the crisis is over, to no avail. JPMorgan’s Dimon said Monday that he believes “this part” of the banking crisis is over. Federal Reserve Chairman Jerome Powell on Wednesday vouched for the health of the financial system.

A renewed selloff on Thursday focused on PacWest Bancorp and Western Alliance Bancorp, two smaller regional banks whose shares have been under pressure since the Silicon Valley bank failed in mid-March and set off the current crisis. PacWest fell 51% after admitting it was considering putting itself up for sale.

PacWest was targeted because of its high concentration of large, uninsured deposits from venture capital and tech customers, the same types of customers who started bank runs in Silicon Valley and the First Republic. UBS analysts estimate that about 23% of PacWest’s deposits come from the venture capital and tech space.

But even Midwest regions like Comerica and KeyCorp are down more than 20% this week. This may reflect growing concerns about large volumes of real estate loans, especially in the office property market, which is bearing the brunt of the pandemic.

PacWest, based in Los Angeles, and Western Alliance, based in Phoenix, each issued a statement overnight saying they were not experiencing any normal deposit withdrawals following the sale of First Republic. Both saw significant withdrawals following the Silicon Valley Bank failure, but banks say deposits have increased since March 31.

Western Alliance issued a separate statement Thursday morning denying a story in The Financial Times that said the bank was considering a sale. Its shares fell 38%.

Investors may fear that PacWest’s fate could be similar to that of First Republic, which spent weeks looking for a buyer before failing. First Republic also served a wealthy clientele, many of whom pulled fast deposits when Silicon Valley failed. The rapid rise in interest rates over the past year also eroded the value of large loans issued by the bank when rates were much lower.

“The underlying issue, especially in these banks, is their assets and the deposit mix is ​​not sustainable. “Deposits are going out the door or banks are paying a heavy price for them,” said Chris Caulfield, a banking industry consultant in West Monroe.

In another sign of potential trouble, a major deal in the banking sector was canceled on Thursday. TD Bank Group and First Horizon Corp said they called off a planned merger, citing regulatory hurdles. Toronto-Dominion Bank said in February it was buying regional bank First Horizon in an all-cash deal worth $13.4 billion.

The Federal Reserve’s fight against inflation played a significant role in the banking turmoil. The Fed on Wednesday raised its key interest rate by a quarter point to the highest level in 16 years as part of that campaign, its tenth consecutive rate hike.

Higher rates have prompted depositors to move money into higher-paying certificates of deposit and money market funds. He also played a role in the downturn in the tech industry, which had major implications for West Coast banks like those in Silicon Valley.

Chair Jerome Powell said the Fed would monitor a number of factors, including turmoil in the banking sector, in deciding its next move on rates.

The Fed chair emphasized her belief that the collapse of the three big banks over the past six weeks would reduce lending to other banks, and that would help the Fed fight inflation. The Fed’s rapid rate hikes over the past year have begun to slow the economy, and many economists expect a recession in late 2023 or early 2024.

Powell also said he agreed with the findings of a Fed report released last week, which said lapses in supervision contributed to the collapse of Silicon Valley Bank, and recommended tighter regulation of the banking industry.

JPMorgan estimates that bank stocks will remain under pressure due to regulatory and economic uncertainty, among other factors.

“Regulatory concerns are mainly around how much banks need to add to capital, liquidity and credit, which will strengthen them for the long term but hurt (earnings per share),” analysts said in a note.

Updated: 05 May 2023, 03:53 AM IST