How the banking crisis could ripple through the economy
Why it matters: The economy runs on credit and loans. Should that activity slow or grind to a halt, there would be domino effects for hiring, spending and more — particularly if banks that are the most active lenders to small and midsize businesses are forced to retrench.
The backdrop: Before the banking turmoil in recent weeks got underway, banks were already tightening up on lending.
- A quarterly survey of loan officers by the Fed showed that a net 40% reported tighter standards for loans to businesses in the final quarter of last year. Excluding the onset of the pandemic, that's the highest share to say so since 2009.
The big picture: Banks face the risk of a two-pronged problem. Unfortunately, those are assets and liabilities.
- That is to say, credit conditions could tighten as people pull bank deposits (which are liabilities) and because of further losses on loans and securities (assets).
State of play: Total bank deposits have been falling for nearly a year — to $17.6 trillion last week from $18.1 trillion last April — as Americans shift money out of bank accounts that pay little interest to higher-yielding savings vehicles, like Treasury bills and money market mutual funds.
- If that accelerates due to fears for deposit safety, it would cause affected banks to shrink the asset side of their balance sheet, mostly by making fewer loans.
- A shift away from smaller banks toward bigger ones leaves overall numbers steady, but would still restrict the availability of credit for the kinds of smaller business and real estate investors that rely on community banks.
What they're saying: "Banks might basically say, 'we can't make as many loans' because they fear they won't be liquid enough to pay out the deposits," says Kathy Bostjancic, chief economist at Nationwide.
- Banks might also worry that after the banking crisis, regulators and supervisors may scrutinize them even more closely, making them more wary of expanding their balance sheets.
Between the lines: Businesses would have a more difficult time accessing the cash necessary to hire more workers or spend on new equipment needed to expand the business. Consumers, too, might have a more difficult time getting a loan.
- On a large enough scale, that would ripple out to the labor market and consumer demand, and in turn may help cool price gains.
The bottom line: No one knows, however, how big of a credit crunch is ahead and to what extent it will crimp economic activity.
- Economists at Goldman Sachs say that tighter lending would result in a drag of as much as a half-percentage point on U.S. growth over his year.
- But economists there warn the drag could be greater, "particularly in the event of further bank failures, significant regulatory changes, or continued deposit outflows that increase the sensitivity of lending to bank capital."