Fed’s feared credit crunch may already be happening

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After a year of high-interest rates, the Federal Reserve is facing its first significant hurdles as decisions made at hundreds of banks will add up – or not – to a drop in lending.

Jeffrey Haley, chief executive of the American National Bank and Trust Company, saw the squeeze coming earlier this year.

Rising interest rates and a slowing US economy mean he thinks credit growth will likely drop by half as the Virginia-based community bank shifts its focus to better quality operations and returns rather than volume.

Following this, a pair of US regional banks abruptly collapsed in mid-March. Instinct told Haley that things would tighten further, with credit growth plummeting to perhaps 25% of what it was in 2022, when the bank’s portfolio rose 13% to about $2.1 billion.

Going into 2023 “my ruler was whatever I did last year, I’ll probably do half of this year,” Haley said. “Based on current events…I think it will be cut in half again.”

After a year of rate hikes, the Federal Reserve is facing its first significant hurdles as decisions made at hundreds of banks will add up – or not – to a drop in lending.

Raising the base interest rate, in theory, reduces the demand for goods and services, and over time also reduces inflation. The concern now is how far and how quickly this unfolds.

Families and businesses are protecting their bank accounts against a very quick economic downturn. And overall bank credit has been stuck at about $17.5 trillion since January. Year-on-year growth has been losing steam fast and the Fed’s next interest rate decision in May now depends on whether policymakers understand whether this is just a result of monetary policy tightening or something deeper.

Voltage

US inflation remains more than double the central bank’s 2% target and, for now, policymakers seem to agree that another rate hike at the May 2-3 meeting is warranted.

But the potential for a worse-than-expected credit crunch remains high in the wake of the collapses of Silicon Valley Bank and Signature Bank last month, which raised concerns of a broader financial panic.

The worst seems to have been avoided. Emergency measures taken by the Fed and the US Treasury protected depositors at both banks, helping to alleviate what could have been a destabilizing run from smaller banks to larger ones. Other Fed actions also helped maintain confidence in the broader banking system.

However, the market was already buzzing after a year of rate hikes that put pressure on smaller banks, which were already competing for deposits that were being channeled into Treasuries and markets that paid higher returns.

The answer – less borrowing, tighter credit standards and higher loan rates – was already taking shape. Bank executives are now looking for signs that the process has been pushed too far.