While Silicon Valley Bank and Signature Bank's failures may seem like old news, concerns about deeper problems in the banking sector that could harm the overall economy and S&P 500 are still alive.
Despite the growth in the sector's stocks following last week's Federal Reserve decision, experts warn that one move will not solve all the underlying problems, so caution should be exercised.
One of the biggest concerns lies in the commercial real estate sector, where small banks hold 70% of the debt, much of which is close to default, a challenge that will not be resolved quickly.
Moreover, despite some improvement in bond prices, unrealized losses on financial institutions' investment securities remain high: about $513 billion in the second quarter, up from $750 billion in 2023.
But is there cause for concern?
First, these losses only become real if banks are forced to sell their assets. The good news is that, with the Fed's pivot to lower interest rates, things should improve significantly as bond prices rise.
However, in practice, even after the Fed decided to cut interest rates by 50 basis points, yields on longer-term Treasury bonds, like the 10-, 20-, and 30-year bonds, are still elevated.
As for the potential fallout from the commercial real estate sector, most banks have set aside billions as a cushion against potential borrower defaults. Those facing difficulties also have options.
Specifically, they can refinance their loans or negotiate better repayment terms. Lower rates are expected to make payments more bearable for borrowers with variable-rate loans.
What about the Basel III changes?
Recently, bank stocks have been pressured by the prospect of tighter capital requirements, which banks must maintain to protect against credit, operational, and market risks.
The underlying idea is to avoid situations like the one with Silicon Valley Bank, where news of liquidity problems triggered panic among depositors and eventually led to the bank's failure.
The problem is that, according to the banks themselves, this initiative could cut bank profits and make it more difficult for individuals and companies to obtain loans, which could harm the economy.
On the bright side, due to growing industry discontent and FDIC resistance, the new draft will only increase capital for large banks by 9% instead of the 20% previously proposed.
The bottom line?
Although the industry faces some challenges, the decline in rates should improve the financial health of many institutions, provided there are no unforeseen events.
