The Banking Crisis: A Slow Bleed that May Trigger a Recession

The Banking Crisis: A Slow Bleed that May Trigger a Recession

The banking crisis that started two months ago is showing signs of being a slow bleed that could act as a catalyst for a recession later this year. Banks are reporting the impact of a run on deposits on their operations, and the picture is mixed. Larger institutions like JPMorgan Chase and Bank of America sustained far less of a hit, while smaller counterparts such as First Republic face a much tougher slog and a fight for survival. The small banks are going to be lending less, which is negative for growth.

Potential Recession and Future of the Banking Sector

The banking stress stabilized by the end of March and was contained at a limit set of banks. The reading on first-quarter economic growth is expected to be positive despite the banking problems. When the Commerce Department releases its initial estimate on gross domestic product gains for the first three months of the year, it’s expected to show an increase of 2%. That growth, though, isn’t expected to last, due primarily to two interconnected factors: the Federal Reserve interest rate hikes aimed purposely at cooling the economy and bringing down inflation, and the constraints on small-bank lending. First Republic, for one, reported that it suffered a more than 40% decline in deposits, part of a $563 billion drawdown this year among U.S. banks that will make it tougher to lend.

However, many economists expect any recession to be shallow and short-lived. The most recent recession was just two years ago in the early days of the Covid crisis. The downturn was historically steep and short, ended by an equally unprecedented fusillade of fiscal and monetary stimulus that continues to flow through the economy. Consumer spending has seemed to hold up fairly well in the face of the banking crisis, with Citigroup estimating excess savings of about $1 trillion still available.

The damage from the banking crisis has been confined, and the Federal Reserve’s periodic “Beige Book” report released in April indicated only that lending and demand for loans “generally declined” and standards tightened “amid increased uncertainty and concerns about liquidity.” The fallout from the crisis seems less serious than expected just a few weeks ago. While the banking situation is a headwind, it’s not a gale-force headwind, just kind of a nuisance.

Where things go from here depends greatly on the consumers who account for more than two-thirds of all U.S. economic activity. Lower-income consumers have been facing pressure for years as the share of wealth held by the top 1% of earners has continued to climb. Before any of the banking crisis started unfolding in early March, there were already starting to see signs of contraction and reining in of credit. Consumers and businesses are pulling in the deck chairs, and as the demand for services catches up to pre-pandemic levels, cracks are forming. While chances for a steep recession are slim, it’s hard to envision how we sidestep at least a minor recession. The real question is how far can the strength of the labor economy and still-significant cash reserves that many households have propel consumers forward and keep the economy on track.


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