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Compliance & Risk

Scale of US banks’ unrealized losses, distressed borrowing & central bank actions point to wider problems

Henry Engler  Thomson Reuters Regulatory Intelligence

· 5 minute read

Henry Engler  Thomson Reuters Regulatory Intelligence

· 5 minute read

Evidence is growing to suggest that the scale of the banking crisis in the United States is much broader than previously assumed

The estimated level of unrealized losses on bank balance sheets and borrowing by banks at the Federal Reserve’s discount window and from the Federal Home Loan Banks (FHL Banks) point to a financial situation in which many regional and smaller institutions are in need of financial assistance — warranted or not. Added into the mix is the fallout from, and central bank response to, the downturn at Credit Suisse and the bank’s brokered sale to UBS earlier this month.

It is often easy to view bank failures in isolation — a singular failure in bank management and perhaps even in regulatory oversight. As with most past financial crises, however, the failure of one institution often prompts questions as to whether those individual problems reflect similar issues elsewhere.

Here are just a few items and recent regulatory actions that might suggest a wider problem:

Unrealized losses on the balance sheet

Part of the demise of Silicon Valley Bank had to do with an accumulation of assets such as long-dated U.S. Treasury and mortgage-backed securities that were purchased before the Federal Reserve embarked on its policy of monetary tightening.

Once the Fed began raising interest rates, these securities became paper losses on SVB’s balance sheet, but SVB was not alone. According to the chair of the Federal Deposit Insurance Corporation (FDIC), there were $620 billion of such unrealized (or paper) losses sitting on U.S. bank balance sheets in early March. Further, some experts believe the figure is understated, with two recent estimates suggesting the outstanding losses could be as much as $1.7 trillion.

Where such unrealized losses sit within the banking system, whether among large regional banks or more broadly among smaller, community banks, remains unclear.

Fed discount window borrowings surge

What is clear is that SVB’s collapse led to a surge in so-called discount window borrowings from the Federal Reserve. The Fed, through its discount window, helps depository institutions manage their liquidity risks and avoid actions that have negative consequences for their customers, such as withdrawing credit during times of market stress.

In October 2008, the month after Lehman Brothers collapsed, the Fed loaned out a then-record $110 billion to banks in one week, through the discount window. That amount is roughly equal to $153.8 billion in today’s money.

By comparison, in the week ended March 15, the Fed lent $152 billion at the discount window and another nearly $12 billion under an emergency lending program announced last week, following the SVB failure.

Federal Home Loan Bank borrowings

Another sign that causes concern is the rise of bank borrowings from FHL Banks, which are regional government-chartered institutions that raise money for low-cost lending to their members, and a vital source of funding to regional banks. FHL Banks are often a preferred final stop for cash before banks in need turn to the Fed itself as a last resort.

According to recent data, the Federal Home Loan Bank System (FHLB) issued nearly $250 billion of debt during the second week of March to provide liquidity to regional and community banks.

“The $1.25 trillion-asset system of 11 regional banks issued a combined $136.5 billion in discount notes and bonds on Tuesday and Wednesday [March 14 & 15], a tapering from Monday’s $111.8 billion — the largest single day of issuance in the Home Loan banks’ 90-year history,” said a report from the American Banker publication.

Banks often turn to the FHLB during liquidity crises, said Kathryn Judge, an expert on banking crises at Columbia Law School. “I would expect borrowing to be way up, so I’m far from surprised by the figures,” Judge says. “The interesting question this time around is whether the FHL Banks will be able to borrow enough to provide advances to all of the member banks that want them. A related challenge is that the FHL Bank system has become far more reliant on short-term sources of funding, so that system as well is more vulnerable than it has been traditionally.”

Central banks coordinate action

Late this past weekend, major central banks announced plans to increase dollar liquidity through international swap line agreements.

“The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank announced on March 20 a coordinated action to enhance the provision of liquidity via the standing U.S. dollar liquidity swap line arrangements,” the Fed said in a statement.

The announcement came after Swiss regulators secured a deal whereby UBS would buy Credit Suisse for $3.25 billion after a frantic weekend of negotiations to safeguard the country’s banking system and attempt to prevent a crisis from spreading across international markets. The deal emerged after five days in which the Swiss regulators raced to end a crisis at Credit Suisse that threatened to topple the country’s second-largest lender.

The liquidity risks of some U.S. banks may be far removed from the long-standing problems of Credit Suisse, but the timing of the two suggest bank regulators are very concerned about the effects of contagion and potential lack of confidence in the international banking system.

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