Strategic Intelligence editor Jim Rickards discusses the Fed’s decision to raise rates by 25 basis points, arguing that policymakers are “determined” to get inflation under control.
The recent spate of bank failures is having a ripple effect on the economy, posing a potential credit crunch that could disproportionately impact small businesses.
The Federal Reserve and Wall Street economists are warning that lending standards may become significantly more restrictive in the coming months due to ongoing turmoil within the financial system caused by the sudden collapse of Silicon Valley Bank and Signature Bank.
During a credit crunch, banks raise their lending standards, making it challenging for businesses or households to secure loans. Borrowers may have to agree to more rigorous terms, such as high interest rates, as banks attempt to minimize their financial risk.
“Tighter conditions can happen and occur outside the official tightening of the Fed funds rate. There are so many other variables,” explained Jeffrey Roach, chief economist at LPL Financial. “A banking crisis, in essence, can tighten conditions. … I think it’s fair to say that the current banking crisis could also be an equivalent to say, a 50 basis point rate hike.”
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Employees walk outside the shuttered Silicon Valley Bank headquarters on March 10, 2023, in Santa Clara, Calif. (Justin Sullivan/Getty Images / Getty Images)
Small businesses are particularly at risk from tighter credit conditions, especially with regional banks at the center of the crisis. Regional banks, community banks, and credit unions often serve as the primary providers of loans for businesses with fewer than 99 employees.
“Banks are tightening lending conditions, so, yes, availability of credit is shrinking. And that’s clearly going to impact small businesses,” said Roach. “Regional banks do provide a large chunk of small business loans. When there’s a challenge there, small businesses are going to feel it right away.”
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Banks were already tightening lending standards before the crisis began. A quarterly survey conducted by the Fed revealed that an increasing number of banks had tightened their lending standards and experienced reduced demand in the last three months of 2022.
This tightening was due to the Federal Reserve’s aggressive measures to combat inflation, which is still running at a rate three times higher than pre-pandemic levels.
Pedestrians near the U.S. Treasury building in Washington, D.C., on Dec. 30, 2022. (Ting Shen/Bloomberg via Getty Images / Getty Images)
However, concerns about a broader financial crisis have complicated the Fed’s efforts. The rapid increase in interest rates played a direct role in the failure of Silicon Valley Bank, and higher interest rates could worsen instability within the financial system.
During the Fed’s recent two-day meeting, Chairman Jerome Powell acknowledged that the upheaval in the financial sector could result in tightened credit for American households. He suggested that stricter lending standards could have a similar effect on inflation as a rate increase.
“Such a tightening in financial conditions would work in the same direction as rate tightening,” Powell stated. “You can think of it as being the equivalent of a rate hike or perhaps more than that.”
Jerome Powell, chairman of the U.S. Federal Reserve, speaks during a news conference in Washington, D.C., on March 22, 2023. (Al Drago/Bloomberg via Getty Images / Getty Images)
These comments came shortly after policymakers implemented another quarter-percentage point rate hike, increasing the benchmark funds rate to a range of 4.75% to 5%, the highest level since 2007. This marked the ninth consecutive rate increase aimed at combating high inflation.
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“Financial conditions seem to have tightened and probably by more than the traditional indexes say,” added Powell. “The question for us, though, is how significant will that be — what will be the extent of it and what will be the duration of it?
“We’ll be looking to see how serious is this and does it look like it’s going to be sustained. And, if it is, it could easily have a significant macroeconomic effect, and we would factor that into our policy decisions.”
An SVB logo and U.S. flag in an illustration on March 13, 2023. (REUTERS/Dado Ruvic/Illustration / Fox News)
SVB primarily served tech companies, venture capital firms, and high net worth individuals, who rapidly withdrew their funds as the once red-hot tech sector cooled down. When the bank announced its attempts to raise capital from investors and its $1.3 billion loss on long-term securities that lost value due to higher interest rates, depositors panicked and initiated a bank run.
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Within days, U.S. regulators took extraordinary measures to contain the consequences of the bank’s collapse and restore confidence in the financial system. These measures included protecting all deposits at the two banks, even those exceeding the FDIC’s $250,000 insurance limit.
The Fed also introduced a new emergency backstop to help lenders handle deposit withdrawals on favorable terms.
