Why are US banks wobbling and how might this impact Singapore?

SINGAPORE - United States regional banking stocks declined on Thursday despite reassurances from Federal Reserve chairman Jerome Powell that the country’s banking system is “sound and resilient”, and that Monday’s sale of First Republic Bank to JP Morgan had helped to “draw a line” under the country’s bank turmoil.

The decline was led by an over 50 per cent drop in the shares of California-based PacWest Bancorp after the media reported it was in talks with potential investors.

Another bank, Memphis-based First Horizon, fell more than 33 per cent after plans for it to be acquired by Toronto-Dominion Bank for US$13 billion (S$17.2 billion) fell through due to “regulatory uncertainty”, the Canadian bank said.

Investors are nervous after the

May 1 collapse of First Republic,

which came a week after it announced that deposits had fallen by 41 per cent, or around US$100 billion, during the first quarter of 2023.

First Republic’s failure also came on the heels of the

closures in March of Silicon Valley Bank and Signature Bank

, which also suffered from a rush in deposit withdrawals. Silvergate Bank also closed after it was unable to recover from doing business with the now-bankrupt crypto exchange FTX.

Although shares of PacWest and other regional banks rebounded on Friday, the KBW Regional Bank index is still down by around 30 per cent in 2023, with many experts warning that more turmoil in the sector is yet to come.

Why are multiple US regional banks failing?

The sector’s woes are partly due to the

Fed’s rate hikes.

The US central bank has increased rates by five percentage points in the past 14 months, and this has hammered the value of banks’ long-dated bond investments, leading to unrealised losses totalling around US$1.84 trillion, according to Bloomberg.

This means that banks in need of funds can only sell their bond holdings at a loss. Other options to raise cash, such as through the stock market, have also become untenable as the value of banks’ shares has fallen.

Meanwhile, the rising cost of deposits fuelled by the rate hikes has eaten into the profits of some banks at a time when depositors have also been withdrawing more funds to support their businesses in a tougher environment.

As pressure on the sector grew, those with bank deposits above the Federal Deposit Insurance Corporation’s US$250,000 guarantee limit were persuaded to withdraw their unprotected money, leading to a jump in deposit withdrawals from smaller banks to the larger institutions.

Deposits are the lifeline for a bank, and with withdrawals mounting, those that have less diversified business models and fewer resources to defend themselves are coming under strain.

What are the consequences for the United States?

In his statement on Wednesday’s Federal Open Market Committee (FOMC) meeting, Mr Powell said that the US economy is likely to face further headwinds from tighter credit conditions.

“Credit conditions had already been tightening over the past year or so in response to our policy actions and a softer economic outlook. But the strains that emerged in the banking sector in early March appear to be resulting in even tighter credit conditions for households and businesses.”

These conditions are likely to weigh on economic activity, hiring and inflation in the US in the months to come, Mr Powell added. This is despite Friday’s data

showing the US adding more jobs in April than expected

and unemployment falling to a multi-decade low.

With banks now expected to pull back on lending, one sector where activity is likely to slow is construction and real estate, where a steady stream of funds is needed to bankroll projects.

In the US, small to mid-sized regional lenders finance 80 per cent of all the commercial real estate industry’s debt, analysts said.

How will this impact Singapore?

The Singapore economy could be affected if activity slows in the US.

Much of Singapore’s gross domestic product comes from external trade, and the US was Singapore’s third-largest trading partner, with $132.7 billion worth of merchandise trade conducted, in 2022, according to the Department of Statistics.

The manufacturing sector here could take a further hit. Growth in the sector, which accounts for 42 per cent of Singapore’s manufacturing output,

eased for the second straight month in April

amid a global slide in demand for electronic goods, including in the US.

Weighed down by this sector, Singapore

grew by just 0.1 per cent in the first three months of 2023

compared with the same period in 2022, challenging the Ministry of Trade and Industry’s forecast that the economy will expand by 0.5 per cent to 2.5 per cent in 2023.

In his FOMC statement, Mr Powell said that future policy actions to taper inflation would also take financial developments, among other things, into account.

This deviates from his usual statement anticipating that additional policy firming may be needed to taper inflation, said UOB senior economist Alvin Liew, who expects just one more 25 basis-point hike, in May, for the rest of the year.

A pause in US rate hikes could taper a jump in deposit rates, which has benefited the local banks. On the other hand, mortgage holders and business owners could see some reprieve from less volatile interest rates. It could also lead to a weakening of the US dollar against the Singapore dollar, making local exports more expensive.