The Simple Fix for Bank Problems

More funding is required for the banking sector. Throughout the past year, this problem has grown within the financial sector. It has come into focus as a result of events this month. For the foreseeable future, the need for increased capital must be the top priority for banks and their regulators, barring a rapid decrease in interest rates to levels seen in 2021.

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Almost the whole sector has robust capital levels, and top American authorities continue to highlight the sector's high capital levels. But, in the end, economic reality always prevails over accounting. This reality is straightforward: as a result of the business's fixed rate assets' declining value, the industry has less capital. Anyone who asserts the opposite is merely relying on the accounting fallacy that unacknowledged losses are not taken into account.

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Analysis is relegated to the backseat while fear takes the wheel in a panic. Analysts with a critical mindset currently have a lot to complain about. If anything, depositors are safer today than they were at the start of the month. Most banks, if not all, are in excellent condition. All banks have immediate access to plenty of liquidity thanks to the Fed's new liquidity facility. Also, the leadership of the sector has demonstrated multiple times that it is prepared to act as a safety net. The issues at Silicon Valley Bank were by no means exceptional, but the bank was by many standards an outlier in its field. Yes, a lot of other banks have substantial embedded losses in their fixed-rate assets, but many of those same banks also have substantial embedded gains in their fixed-rate liabilities, which will partially offset those losses for as long as they can withstand market pressure to change the price their deposits upward.

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Of course, rates won't probably stay the same. Couldn't the Fed just solve the whole thing? Okay, yeah. And should rates return to levels seen in 2021, the demand for capital in the sector would vanish. Nonetheless, inflation is a serious economic issue, and although the Fed is concerned about the stability of the financial system, reducing inflation is more closely related to its primary objectives. The Fed's own track record is also instructive: Paul Volcker, a former Fed Chair, is regarded as a legendary banker precisely since he put managing inflation above all else, adhered to his principles, and was successful despite opposition from the savings and loan sector. In the absence of convincing evidence of an economy that is slowing down, here's hope you get good odds if you want to wager on the Fed changing course and lowering interest rates at some point soon.

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Not because we are destined to experience another savings and loan crisis, but rather because it emphasizes the significance of taking prompt action to solve the capital difficulties facing the banking industry. No matter what their reported capital numbers may indicate, bankers who are aware that their institutions are close to being worthless have every incentive to take on more risk because they know that any winnings will go to them and their shareholders, while any losses will be covered by the Federal Deposit Insurance Corp.

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Therefore, it seems unduly dramatic to make claims that a fresh S&L crisis is at approaching or that several bank failures are to be expected. There is always potential for things to go worse, and there is always a chance that a significant long-term issue could become a genuine crisis. But if we use them wisely, we have the opportunity and the resources to avert the worst-case scenarios.

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Similar to this, claims that we need to reform laws or regulations in order to handle the situation strike me as counterproductive. Even if we had a Congress that was capable of producing it, passing legislation takes months even when it proceeds fast. Establishing interagency rules typically takes much longer. But, bankers already understand how to raise capital, and regulators are well-equipped to compel refractory parties to act appropriately. The goal is to keep the underlying issue—capital—in mind as we move forward.