John Rapley is a political economist at the University of Cambridge and managing director of Seaford Macro.
For every bank in Canada, there are 60 in the United States. That gives you an idea of the scale of the challenge before American authorities as they grapple with what is turning out to be a weekly roll call of failing banks.
On the one hand, a handful of failures at small regional institutions isn’t going to metastasize into a full-blown financial crisis, not least because the big banks are only too happy to swoop in and pick up the scraps on the cheap. But on the other, the fact that the financial system is absorbing these failures means this could have a long way to run, which will ultimately hobble the economy.
When it comes to their banking systems, Canada and the U.S. could hardly look more different. Unlike Canada’s centralized, highly regulated financial system, in which a small number of large banks dominate affairs – with an economy less than a 10th the size of its southern neighbour, Canada has almost as many banks in the global top 50 – the U.S. remains wedded to its decentralized system of small regional banks.
Reflecting this localism, the U.S. has no central bank as such, the Federal Reserve system being in fact a network of regional central banks. And even that nod to a reserve banking system was a reluctant concession, one adopted early last century in response to a banking crisis, some centuries after Europe’s great central banks had been born.
American exceptionalism is more than just cultural, though. Regional banks are the backbone of local communities, and provide much of the financing for the ecosystem of startups that has defined the United States’ success at innovation for centuries. But that also makes them vulnerable to downturns in local economies.
It’s no coincidence the runs started in California, among banks that were highly exposed to the tech sector – and which also, some add, favoured a risk-taking “move-fast-and-break-things” approach to banking that led to plenty of innovation but ultimately broke the banks themselves. In the cheap-money days, they were happy to borrow for next to nothing and invest in speculative ventures, some of which promised big returns. But when interest rates shot up, this business model went awry, making a shakeup inevitable.
More broadly, given that they lend to local businesses, regional banks are also disproportionately exposed to the commercial property sector. As I have been writing since the start of the pandemic, this was always going to be the sector that would recover slowly, if ever, from the economic shock of the lockdowns.
While the banks were able to postpone the day of reckoning by continuing to inflate the book value of their assets, the need to generate cash for antsy depositors has now started the process of liquidation. Those losses are coming onto the books, so we can expect there will be more of this for a while.
The U.S. will never develop into a Canadian-style system, but it will nonetheless continue to see further industry concentration as the big players, which are more tightly regulated and well-capitalized, pick up failing regional banks. Some of this results from the Trump-era loosening of regulation on smaller banks, which may have seemed like a good idea in good times but is now turning out rather badly.
Canadian-style regulation may sometimes grate with its customers, given the higher fees and less generous offerings that can result, but we see its virtue in times like these. In effect, in the U.S. right now, some depositors are opting to flee the comparatively light regulation of regional banks to shelter their money in the safer haven of the big beasts.
Sooner or later, to stem this outflow, the authorities will have to guarantee depositors’ money, which will require them to step in and regulate the sector more tightly. In the meantime, given the damage is largely confined to small banks, this won’t metastasize into a full-blown financial crisis. But its effects will linger.
Precisely because regional banks invest in local communities, commercial real estate and new businesses, any reduced activity on their part could crimp the economy at a delicate time. Although incomes and spending remain fairly firm, business confidence is dropping, and many economists now expect the economy to come close to recession this year, possibly even falling into a shallow one.
These bank runs, with their attendant effects on lending, are the very sort of thing that could tip things over the edge.