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What's next for US regional banks after the Fed pauses interest rate hikes?

Following the US Federal Reserve pausing interest rates, we look at what this could mean for US regional banks.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

The Federal Reserve (Fed) has finally pressed pause on interest rates, even though policy makers at the central bank are still worried about the risks that inflation will stay higher for longer.

The Fed flagged that there could be further hikes to come, but are adopting a wait and see stance. It's in contrast to the European Central Bank which has continued on its rate hike path.

Why is the Fed pausing rates?

One of the reasons why the Fed could be opting for a stop-start approach is due to concerns about the effect of further rate increases on the regional banking sector.

Troubles erupted in March when three of the nation's 30 largest banks failed over a weekend. High interest rates contributed to the collapses.

What caused the US banking crisis and what could come next?

Investors are still unconvinced that the problem will be contained and fear there could be more collapses, despite regulators and the US Treasury standing by with additional support. Although banks have been provided with funding options giving them enough money to meet sudden withdrawals, questions remain over some of these banks' ability to make profits over the longer term.

Valuations are also weaker, with a key banking index of regional banks down around 19% year to date.

The commercial property problem for US regional banks

One of the big worries is their exposure to the commercial property sector. Regional banks are among the largest lenders to real estate, particularly the office sector. There has been a permanent shift to remote working, and vacancy rates are still high, particularly in states like California. Companies requiring refinancing will be squeezed by higher interest rates.

As a result, there are concerns there might be more defaults on commercial property loans and some banks are already offloading parts of their portfolios at a loss.

The worry is that there could be another confidence crisis, with bank stocks coming under renewed pressure unsettling depositors whose money isn't fully insured, even if the bank does have adequate funding.

Given concerns about fragility in the sector, regulators are mulling what further action could be taken.

The door remains firmly open for more concentration with more banks merging or being bought by bigger, stronger players. JPMorgan, the largest bank in America, has already become even bigger after taking over First Republic Bank.

This could naturally raise concerns about banks being far too big to fail though, putting the government on the hook for mega-bailouts in the event of an incident like the great financial crisis in 2008.

However, that's far from a certainty and the Treasury Secretary Janet Yellen, has once again stressed that the banking system overall is safe and sound.

This article isn't personal advice, if you're not sure what's right for you, ask for financial advice.

Interest rates, inflation and recession in the US – what are the experts saying?

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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