Danger Signs: Troubled Banks

Credit rating agency Moody’s is warning that the financial strength of American banks is likely to erode in the coming year as the Federal Reserve’s rapid interest rate increases “have a material impact on the U.S. banking system’s funding and its economic capital.” In downgrading its ratings on ten regional banks and putting major lenders like Bank of New York Mellon and U.S. Bancorp on review for a possible downgrade, Moody’s delivered a stark reminder that banks are not in the clear after the panic that led to the failure of Silicon Valley Bank and Signature Bank in March of 2023. The stock market plunged as the banks failed, and gold soared, climbing as high as $2,055 the ounce, just days after the failure of another bank, First Republic, in early May.

The jump in interest rates has punished the value of bonds and loans that banks hold, leaving them exposed to “sizeable unrealized losses,” Moody’s cautioned. At the same time, banks have had to pay more to attract deposits. Even that may not be sufficient to hold onto capital, the rating agency warned, arguing that “there remains a significant risk that systemwide deposits will resume their decline in coming quarters.”

Yet another concern is the risk of rising loan losses, particularly if the U.S. falls into a recession, which the ratings agency is anticipating in early 2024. “Asset quality will worsen and increase the potential for capital erosion,” Moody’s predicted.