The International Monetary Fund (IMF) has estimated that the recent failure of two midsize American banks and subsequent tighter bank lending will lead to a slowdown in US economic growth for the current year. Furthermore, the IMF has cautioned that the increase in interest rates poses a potential threat to the global financial system.
According to the report on global financial stability released by the IMF on Tuesday, the recent reassessment of the health of midsize banks by investors, resulting in the fall of value of many bank stocks, will cause a decline of 1% in the lending capacity of US banks this year. The IMF predicts that this reduction in lending will lead to a 0.44 percentage point decrease in the US gross domestic product in 2023.
The IMF stated that the regional and smaller banks in the US make up over a third of the total bank lending, and hence, a withdrawal from credit provision by these banks could significantly affect the economic growth and financial stability.
The IMF released a separate report on Tuesday, in which it predicts a growth rate of 1.6% for the US economy, which is the largest economy in the world. This is a decline from 2.1% in 2022. The report also forecasted a global economic growth rate of 2.8% for this year, which is slower than last year’s growth rate of 3.4%. The slowdown is due to the continued recovery of nations from the pandemic and the war in Ukraine.
In March, Silicon Valley Bank faced a failure as depositors withdrew their money due to significant unrealized losses in its long-term investments in Treasurys and mortgage-backed securities. The bank had purchased these assets when interest rates were very low, but the value of these assets decreased as the U.S. Federal Reserve raised interest rates quickly over the past year to combat high inflation.
After concerns about bank runs spread to other banks, U.S. regulators shut down Signature Bank based in New York. Following this, Swiss authorities stepped in and prevented a dangerous decline in confidence in the global banking system by enforcing the acquisition of Credit Suisse Group AG by its long-time rival UBS Group AG.
According to the IMF, the global economy is still at risk due to high inflation and rising interest rates. With many financial institutions having enjoyed ultracheap borrowing rates for years, the IMF warns that these institutions may have difficulty adjusting to the elevated interest rates brought on by the highest inflation seen in decades.
As per the IMF, the critical issue that market participants and policymakers need to address is whether the recent incidents are a sign of more extensive systemic pressure that will challenge the global financial system’s stability.
According to the IMF, the potential for further financial stress and credit tightening could have significant consequences for economies of all sizes. This poses a challenge for central banks as they try to tackle the issue of high inflation. The IMF has encouraged policymakers to communicate their commitment to addressing inflation, even if it means making difficult choices that could affect financial stability.
Furthermore, the commercial real estate sector has become a growing source of risk due to lower property valuations and difficulties in finding tenants in the aftermath of the pandemic. This raises concerns about the potential for defaults and their impact on banks that have lent money for commercial real estate. The IMF is urging caution and increased oversight in this sector to prevent a wider financial fallout.
According to the IMF, the commercial real estate (CRE) sector faces a growing risk as companies struggle to find tenants and property valuations decline. The combination of higher interest rates and lower demand for CRE may result in a broader correction to the commercial real estate valuation.
Additionally, the IMF warns that the Federal Reserve’s decision to reduce its holdings of Treasury bonds, combined with the political deadlock over raising the debt limit, could present challenges to an already illiquid and volatile Treasury market.