Financial Turmoil Has Eased, But Risks Still Abound

Banks may face trouble with their bond holdings and real estate loans, thanks to higher interest rates.

Global financial turmoil has calmed in recent weeks, particularly as the U.S. government and Federal Reserve stepped in to help after three U.S. banks failed.

But that doesn’t mean the danger has disappeared.

“Financial stability risks have risen significantly as the resilience of the global financial system has faced a number of severe tests,” according to the IMF Global Financial Stability Report.

In the years after the 2008 financial crisis, extremely low interest rates led investors to increase their risk-taking. But then the Fed and other central banks raised interest rates in 2022-23. Some banks are suffering as a result.

“The sudden failures of Silicon Valley Bank and Signature Bank in the U.S, and the loss of market confidence in Credit Suisse, [which was taken over by UBS], have been a powerful reminder of the challenges posed by the interaction between tighter monetary and financial conditions and the buildup in vulnerabilities,” the IMF said. Silvergate Bank also failed in the U.S.

“Amplified by new technologies and the rapid spread of information through social media, what initially appeared to be isolated events in the U.S. banking sector quickly spread to banks and financial markets across the world, causing a sell-off of risk assets,” the IMF said.

Policymakers Respond, but Risks Remain

Strong moves by policy makers to reduce systemic risk eased market anxiety. For example, in the U.S., bank regulators guaranteed uninsured deposits at SVB and Signature Bank, and the Fed established a lending program for banks to prevent further runs.

The fundamental question is whether recent events are a harbinger of more systemic stress that will test the global financial system, or simply the isolated manifestation of challenges from tighter monetary and financial conditions after more than a decade of ample liquidity, the IMF said.

While the global financial situation has improved, we aren’t out of the woods yet, it concluded.

“There is little doubt that the regulatory changes implemented since the global financial crisis, especially at the largest banks, have made the financial system generally more resilient,” the IMF said. But “concerns remain about vulnerabilities that may be hidden.”

Bonds, Real Estate Loans May Cause Trouble

In the U.S., banks own plenty of bonds that have markedly decreased in value, thanks to the Fed’s rate hikes. U.S. banks’ unrealized losses on securities totaled $620 billion as of the fourth quarter, according to the Federal Deposit Insurance Corp.

Also, commercial real estate could turn into a major problem for U.S. banks, especially small- and mid-sized banks. A total of $270 billion of commercial real estate bank loans mature this year, according to Trepp, a real estate information firm. And most of those loans are held in banks with assets less than $250 billion.

Given the downturn of commercial real estate over the past year, particularly office real estate, some borrowers may be unable to repay their loans. And those who need to take on new debt after their loans expire may have trouble paying the higher interest rates that will be charged on the new loans. Two major office building owners already have defaulted on mortgages.

So we can breathe a little easier for now, but trouble may be coming around the corner.