Fed predicts Credit Crunch amid banking crisis

The US Federal Reserve has cautioned that the recent banking turmoil could trigger a broad credit crunch that could slow the country’s economy. The collapse of Silicon Valley Bank and Signature Bank in March, followed by the First Republic’s collapse last week, has led to concerns about loan losses and deposit flight. The Federal Reserve also said it planned to tighten lending standards amid these worries.

The US Federal Reserve’s semi-annual Financial Stability Report expressed concerns that “the economic outlook, credit quality and funding liquidity” could lead to a further contraction in the supply of credit to the economy. The availability of credit could fall sharply, leading to a rise in the cost of financing for businesses and households, which could ultimately slow economic activity. A credit crunch was cited as one of the top current risks to the financial system, rather than the Fed’s most likely scenario. 

As part of its stability report, the Fed surveyed market experts and academics, who ranked stress in the banking sector as the top threat to stability, quadrupling since the fall and now on par with inflation and US-China tensions. According to this survey, concerns about commercial and residential real estate are also increasing rapidly.

The Fed also released the results of its quarterly opinion poll of senior loan officers on Monday, which showed banks expect to tighten lending standards for the remainder of 2023, with medium-sized banks and other banks more frequently citing concerns about their liquidity positions, deposit outflows, and funding costs as reasons for tightening. The central bank said it will also monitor developments in commercial real estate loans more closely and expand “screening procedures” for banks with a greater focus on the sector.