Chicago Tribune
Back when banking was heavily regulated, the “three-six-three” rule prevailed. Bankers would pay 3% interest on depositors’ accounts, charge a 6% loan rate when lending out the depositors’ money and, with a profit practically assured, tee off on the golf course at 3 p.m.
Starting in the 1980s, deregulation ushered in more intense competition. But even so, banks should be feasting these days. With the economy chugging along nicely, banks with household names are still paying peanuts to many depositors, and charging much more in interest on loans: Mortgage rates recently topped 7%. That should be money in the bank.
The trouble with the banking sector isn’t the current conditions so much as those of the past. America’s banks are struggling to adapt as interest rates continue to soar. While rising rates provide more opportunities to make money on the spread between deposits and loans, they also put pressure on existing loans and investments made before the big run-up in rates. Low-interest loans and bonds lose value when higher-interest versions become available.
Making matters worse is the disaster unfolding in the market for office properties. Many banks made five-year loans at rock-bottom rates when commercial real estate was surging just before the pandemic. In the aftermath, with the rise of remote work, that same real estate has lost value and stopped generating cash flow. That makes it nearly impossible to refinance at today’s higher rates, which have swiftly turned good loans into bad loans.
The financial system survived the shock of three quick failures this past spring when Silicon Valley Bank, Signature Bank and First Republic Bank went under. Americans may look back on August as the month when the broader peril to the financial system became obvious. Earlier this month, Moody’s cut the credit ratings of 10 small- and mid-size banks, announced that it may downgrade several bigger lenders as well and cut its outlook for the industry to negative.
The U.S. financial system remains solvent overall, and no one needs to panic. But the Federal Reserve is in a tussle with bank executives about what to do next.
The Fed may need to continue increasing interest rates to battle persistent inflation, and it’s nowhere near dropping them, so pressure from that part of the equation is likely to continue. On top of that, the Fed in July laid out a sweeping plan to increase capital requirements, forcing banks to hold onto more money to protect against disruptions. The Fed noted that the bank failures earlier this year show that even mid-size institutions can create systemic risks by eroding confidence. A run on even a relatively small bank will do that.
Whatever else happens, the Fed needs to avoid a meltdown like the 2008-09 crisis, when the federal government threw hundreds of billions into righting the financial sector and bailing out giant banks. If higher capital requirements are the price of sidestepping a repeat, the negative effects would be well worth it.
As ever, stick with banks whose executives aren’t making a priority out of midafternoon tee times.
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