Central banks will seek to safeguard financial stability amid growing concerns about their ability to weather the higher interest rate environment, which has resulted in raising fears of a credit crunch, the Swiss Re Institute has stated in a recent report.
Credit has already been tightening in the US and EU, just as smaller banks are experiencing renewed pressure on assets.
This potential credit crunch would involve a sudden and sharp restriction on lending to businesses and households, which could cause serious damage to the real economy.
For example in the Global Financial Crisis (GFC), when banking system failures virtually halted the supply of credit. In the US, monthly business bankruptcies more than doubled to a peak of 8,812 in April 2009 from 4,319 in November 2007, according to the American Bankruptcy Institute.
According to the report, current conditions are not comparable to that extreme, with US bankruptcy filings at a relatively low 1,696 in February 2023.
Instead, analysts expect further credit tightening by banks over the coming quarters. This action would be needed in order to proceed steadily in response to impaired liquidity and the higher-for-longer interest rate environment.
“US banks have been gradually reducing credit supply for the last 18 months, reflecting a weaker and more uncertain macro outlook and reduced tolerance for risk,” analysts explained. “A net 43.8% of banks reported tightening lending standards for small firms in Q1 2023, up from 31.8% in Q4 2022.
“This is corroborated by the NFIB small business survey, which shows net loan availability for small businesses falling since late-2021. Commercial and industrial loan growth, too, has slowed for three months to 13.2% in February from a November 2022 peak of 15.5%. In Europe, banks reported in Q4 2022 the most significant tightening in criteria for approving loans to businesses since the region’s sovereign debt crisis in 2011.”
To bring down inflation sustainably, bank lending and financial conditions would need to both tighten steadily for a prolonged time.
Ongoing credit reductions are worth about 25 to 100bps of policy tightening, implying a US Federal Funds rate of 5.25-6% at the end of the first quarter. This supports the Institute’s view that the Fed is likely approaching the end of its hiking cycle.
Analysts expect financial conditions to tighten further from here, with real estate lending particularly exposed to small bank stress.
However, current tightening falls well short of a credit crunch, the Institute assured in its report, and policymakers are watching closely, with leeway to ease policy again should the situation deteriorate.
