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US banks face catastrophe amid rising interest rates, market shifts

US banks face catastrophe amid rising interest rates, market shifts
Ana Zirojevic

Amid developments signaling the possibility of a widespread financial collapse and signs that major banks are preparing for it as they did in the 2008 recession, a top expert at American credit rating agency Fitch Ratings has highlighted why the banking sector in the United States is at risk.

As it happens, Christopher Wolfe, managing director and head of North American banks at Fitch Ratings, discussed the current state of the US banking sector in an interview with finance and technology reporter and host David Lin streamed on May 24.

Challenges before banks

Indeed, Fitch Ratings last year downgraded the US sovereign credit rating, indirectly affecting finance institutions but not causing immediate negative actions, and Wolfe explained that US banks are currently facing challenges due to interest rate environment changes and the aftermath of the Covid pandemic.

“Largely it has been playing out as we thought. We assumed that the rates were going to be higher for longer, and they have been. The prospects of rate cuts in 2024 continue to diminish. It doesn’t mean they can’t happen, but the likelihood has been marked down, at least in the markets.”

Additionally, he stressed that “banks have to contend with what will be a ‘higher for longer’ environment, and that has had some implications, but, so far, we haven’t been surprised by what we’ve seen,” adding the housing market stability differs from 2007, with less banking sector exposure to mortgage origination.

Large vs. small banks

In terms of the difference between large and small banks, Wolfe has argued that the larger institutions have generally maintained stable liquidity, while smaller banks might be facing tighter liquidity conditions, impacting their funding costs, but that they “wouldn’t be systemic like SVB, Signature or First Republic.”

On top of that, he pointed out that commercial real estate, especially office spaces, faced challenges like valuation declines and refinancing problems, which could have negative implications for financial organizations, albeit more for smaller ones as opposed to larger ones.

Finally, Wolfe considered recession possibility, expecting banks to withstand short, mild pullbacks, though adverse shocks like unemployment spikes, credit card delinquency rates, geopolitical events, or real estate failures could present risks depending on the particular institutions’ sensitivity to such scenarios.

Interestingly, finance experts and government agencies have noted that the 2008 collapse had highlighted hidden leverage in off-sheet assets at Wall Street banks, including JPMorgan (NYSE: JPM) and Wells Fargo, as the key driver of the crisis, having maintained leverage ratios between 16:1 and 22:1 from 2000 to 2007.

Meanwhile, Tiff Macklem, the Governor of the Bank of Canada, has warned that the financial system in this country was on the brink of a significant fallout, citing mounting concerns about housing affordability and a potential increase in capital gains tax rates, as Finbold reported on May 13.

Watch the entire video below:

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