A Warning for the U.S. Banking Sector

Fragility grows rapidly, again

A note. I have been publishing heavy, indepth analytical pieces here for over two years. Now I think that a change is needed. While I (we) continue to publish indepth analyses and forecasts in the GnS Economics Newsletter, I will turn this newsletter more towards commenting of recent events, and warnings. I don’t yet know the exact form this will take. This month will be a test month for me here, which includes dropping the price to $5 for the monthly and to $40 for the annual subscriptions. If you have just purchased access, write to me and I will credit you some extra months (years), if I decide to continue on this line after this month. All comments concerning the change are highly appreciated. Now to this week’s important topic.

Issued discussed:

• Assets of U.S. banks are souring, again.

• The main source of deteriorating asset quality are accumulating loan losses.

• These developments sound a warning of an approaching banking crisis, like in February 2023.

On Friday, October 25, the Office of the Comptroller of the Currency (OCC) closed the First National Bank of Lindsay in Oklahoma. On Monday the 28th, the bank reopened as a branch of First Bank & Trust Co. of Duncan. This was the second bank failure for 2024, compared to five bank failures in 2023, zero in 2022 and in 2021, and four in 2020. Since 2019, there have been 15 bank failures.

Now, as the yields of U.S Treasuries are rising again, the unrealized losses in U.S. banks which stood at $502 billion at the end of Q2, will start growing again. The collapse of the Silicon Valley Bank (SVB) essentially started, when it sold some of its Treasury holdings with a deep discount in an “emergency sale” to meet the deposit outflow caused by emerging problems in the tech sector. News of deep losses from the sales and on the need to raise more capital led to a catastrophic run on the bank’s liabilities with customers trying to pull over 80% of the deposits in just two days.

To safe guard the banking sector, the Federal Reserve created the Bank Term Funding Program (BTFP), from where banks could borrow funds from the Fed against “eligible collateral”, which in effect was any security or a loan to which a bank could attach some market price. The Fed ended the BTFP on March 13, a year after its onset. Currently, the funds borrowed through the BTFP stand at $57 billion, while at the peak, in the third week of January, banks held close to $168 billion worth of funds drawn from the BTFP.

Lending of U.S. banks from the Fed through the Bank Term Funding Program. Source: GnS Economics, St. Louis Fed

Essentially, the Federal Reserve is making U.S. banks vulnerable to another round of runs by removing an important liquidity back-stop for them. The idea of the BTFP was to safe-guard (“guarantee”) deposits in U.S. banks, and soon this support is gone.

On February 24, 2023, I warned on the fragility of the U.S. banking sector. The warning was based on the collapsing ratio of regulatory capital to risky assets. Now, I issue another warning on the growing fragility of the U.S. banking sector for the same reason. This time, however, this warning includes a worrying twist.

Around we go