Bank stresses brings economy closer to recession, Minneapolis Fed’s Kashkari says

The recent stresses in the banking system in the banking system that resulted in the failures of Silicon Valley Bank and Signature Bank will take time to clear up, Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, said during an interview on CBS’s “Face the Nation” Sunday. Those tensions will also move the U.S. economy closer to recession, he added.

“We know there are other banks that have exposure to long-dated Treasury bonds who have some duration risk, as we call it, on their books,” he said. “We also know there are a lot of commercial real estate assets in the banking sector and there are some losses that will probably work its way through the banking sector. So that process will take time to fully become clear.”

Still, he pointed out that the banking system has a lot of capital to be able to withstand those pressures.

The recent stress in the banking sector “definitely brings us closer” to recession, he said. “What’s unclear for us is how much of these banking stresses are leading to a widespread credit crunch.” That credit crunch would then slow down the economy.

On the positive side, those “strains could then bring down inflation, so we have to do less work with the federal funds rate to bring the economy into balance,” Kashkari said. “It’s something to watch very carefully and that’s what we’re focused on.”

He is encouraged that “deposit outflows seem to have slowed down. Some confidence is being restored among smaller and regional banks.”

But at the same time, the “capital markets have largely been closed for the past two weeks. If those capital markets remain closed because borrowers and lenders remain nervous…. this tells me that this is going to have a bigger imprint on the economy,” he said.

Even though banking stresses may slow down the economy, “it’s too soon to make forecasts about the next interest rate meeting,” Kashkari said. “We’re going to continue to let the data and the evidence guide us.”

He sees the need to make U.S. banking regulations more fair for regional and community banks.

“We need regional banks in America. We need community banks in America,” he said. “Once we get through this stress period, we have to come up with a regulatory system that both ensures the soundness of our banking system, but is also fair and even so that community banks and regional banks can thrive. We do not have that today.”

On Friday, UBS analysts said the Fed’s balance sheet implies that liquidity stress is stabilizing.