Fifteen years ago, the world shuddered as it witnessed the failure of IndyMac Bank. Two months later, the $309 billion Washington Mutual Bank fell, marking the start of a devastating recession. Fast forward to 2023, where there has been a series of recent bank collapses, and the question becomes: Is the U.S. on the brink of another financial crisis?
Answering this question is complex. Many banks are invested in a mix of properties that are heavily weighted with commercial and multifamily real estate portfolios, and with the Federal Reserve’s decision to push interest rates to levels not seen in decades, market uncertainty exists.
But uncertainty does not mean that a crisis is brewing.
With careful risk management, oversight, and effective regulation, the industry can navigate the changing financial landscape successfully.
In a recent discussion, experts within the banking industry delved into what the future holds for the banking ecosystem, specifically examining the factors contributing to the potential risk of further failures, including the roles of regulation, commercial real estate, and rising interest rates.
The Changing Landscape of Banking — Does Failure Mean a Recession?
Every year, some banks fail as part of the natural course of business. While the number of failed banks in 2023 has raised alarms, these incidents have been caused by several factors.
Banking Turmoil 2023
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The collapse of banks, such as Silicon Valley Bank and First Republic Bank, resulted from deficiencies in risk management and a lack of proactive supervision; they are unrelated to the bad loan practices of the subprime mortgage crisis of 2008.
Although the future is never definite, what is sure is that rising interest rates have created liquidity challenges on both the asset and liability sides of banks’ balance sheets. This shift may pose a significant challenge to banks worldwide and lead to reduced profitability and increased consolidation within the industry.
Will There Be a Payoff or a Crash From Banking’s Big Bet on Commercial Real Estate?
A particular point of concern for banks in the current financial landscape is their commercial real estate portfolios. Many banks have excessive exposure to commercial real estate in relation to their deposits and capital reserves, which raises questions about whether this could create systemic risk. In light of higher interest rates and the extensive number of loans due, this question has become even more pressing.
According to Trepp, approximately $270 billion worth of bank loans are set to mature in 2023, with a substantial portion linked to office properties. By 2027, the total value of U.S. bank loans that will come due is a staggering $1.4 trillion.
As interest rates rise and workplace culture changes, commercial real estate faces an uncertain future. Increased interest rates raise concerns about the ability of borrowers to refinance loans at favorable terms. And as these commercial loans become more difficult to service, there is a potential for a higher rate of default.
Are Risk Management and Regulation a Path Forward?
It is unlikely that another crisis like the one that rocked the economy in 2008 is on the horizon. However, both policymakers and the banks must work to avoid a financial crisis and ensure that there is a smooth path forward for the sector.
Enhancements in liquidity stress tests, improved stringency of the supervisory framework, and a more coordinated regulatory approach are among the steps that should be taken to minimize the risk to the financial foundation of banks.
Furthermore, allowing institutions to fail on occasion sends a message that the Fed will not bail out all banks. This approach promotes accountability, which can lead to better overall regulation.
While more bank failures are possible, experts are confident that the financial system today is better equipped to handle such breakdowns without causing widespread panic. This confidence is thanks in part to the many protections put in place by the Dodd-Frank Act following the 2008 housing crisis. Furthermore, the U.S. banking system is proving resilient, having effectively weathered recent economic storms, including the unprecedented challenges of the COVID-19 pandemic.
While there are obstacles ahead, it is not likely that 2023 will kick off another global financial crisis. Instead, we are seeing a necessary correction in the banking ecosystem, with a focus on rebalancing portfolios, repricing assets, and returning to a more sustainable and less risky environment. With careful risk management, prompt corrective actions, improved oversight, and clear regulation, the industry can navigate the changing landscape successfully.
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