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Bank shares sold off on Wall Street this week following the government’s seizure and subsequent sale of First Republic Bank to JPMorgan. It was the second largest bank failure in US history and the third failure of a medium-sized lender in two months.

While many thought the sale of First Republic would “put an end to the ‘who’s next?’ “In talks, investors continue to clearly focus on the remaining players considered the weakest,” analysts at UBS wrote in a note to clients.

The bigger concern is that the bank failures could lead to doubts about relatively sound banks, creating a financial contagion that could affect the wider economy. Averting that scenario was the reason the US imposed tighter restrictions on big banks after the financial crisis 15 years ago.

It’s hard to ignore the feeling of banking discomfort right now, although don’t worry if your money is in a bank insured by the Federal Deposit Insurance Corp. and you have less than $250,000 there, which covers most bills.

Bankers and regulators have tried to reassure investors that the worst of the crisis is over, but to no avail. JPMorgan’s Dimon said Monday he believed “this part” of the banking crisis was over. Fed Chairman Jerome Powell vouched for the health of the financial system on Wednesday.

A renewed selloff on Thursday targeted PacWest Bancorp and Western Alliance Bancorp, two smaller regional banks whose shares have been under pressure since Silicon Valley Bank’s mid-March failure sparked the current crisis. PacWest fell 51% after acknowledging it was considering putting itself up for sale.

PacWest was targeted because of a high concentration of large, uninsured deposits from venture capital and technology clients, the same types of clients that caused bank runs in Silicon Valley and First Republic. The UBS analysts estimate that about 23% of PacWest’s deposits come from venture capital and technology.

But even Midwestern regions like Comerica and KeyCorp are down more than 20% this week. This could reflect growing concerns about large volumes of real estate lending, particularly in the office real estate market, which continues to suffer from the effects of the pandemic.

PacWest, based in Los Angeles, and Western Alliance, in Phoenix, each issued statements overnight saying they had no extraordinary deposit withdrawals following the sale of First Republic. Both saw significant withdrawals after the bankruptcy of Silicon Valley Bank, but the banks say deposits have increased since March 31.

Western Alliance issued a separate statement Thursday morning denying a story in The Financial Times that the bank was considering a sale. Shares fell 38%.

Investors may fear that PacWest’s fate could mirror that of First Republic, which spent weeks looking for a buyer before failing. First Republic also provided a wealthy clientele, many who quickly raised deposits when Silicon Valley went bankrupt. The rapid rise in interest rates over the past year had also reduced the value of large loans that the bank extended when interest rates were much lower.

“The underlying problem, especially with these banks, is that their mix of assets and deposits is not sustainable. Deposits keep coming out or banks have to pay hefty prices for them,” said Chris Caulfield, a banking advisor at West Monroe who has worked with many of the region’s troubled banks.

Another sign of potential trouble was Thursday when a major deal in the banking sector was called off. TD Bank Group and First Horizon Corp. said they called off a planned merger, citing regulatory hurdles. Toronto-Dominion Bank had said in February it was buying regional bank First Horizon in a $13.4 billion cash deal.

The Federal Reserve’s fight against inflation has played a key role in the banking turmoil. The Fed raised its key interest rate by a quarter point on Wednesday to its highest level in 16 years as part of that campaign, marking its tenth consecutive rate hike.

The higher rates have prompted savers to shift money into better-paying certificates of deposit and money market funds. They also played a role in the slowdown in the technology industry, which had a major impact on West Coast banks such as Silicon Valley.

Chairman Jerome Powell said the Fed would monitor several factors, including the turmoil in the banking sector, when making decisions about the next interest rate hike.

The Fed Chairman emphasized that he is convinced that the collapse of three major banks in the past six weeks is likely to cause other banks to tighten lending, which would help the Fed in its inflation battle. The Fed’s rapid rate hikes over the past year have slowed the economy, and some economists expect a recession in late 2023 or early 2024.

Powell also said he agrees with the conclusions of a Fed report released last week that lacked oversight contributed to Silicon Valley Bank’s demise, and that he recommends tighter regulation of the banking sector.

JPMorgan expects banking stocks to continue to be under pressure due to regulations and economic uncertainty, among other things.

“Regulatory concerns would primarily translate into how much banks need to add to capital, liquidity and debt, all of which would strengthen them in the long run but hurt (earnings per share),” analysts said in a note.

Updated: May 05, 2023, 03:53 AM IST