The recent failures of the major banks have exposed vulnerabilities in the financial market.
These institutions were handling hundreds of billions, many concentrated in sensitive areas. Their bankruptcies demonstrated the outsized risks these loan portfolios pose.
Now, with questions raised about long-term sustainability, the remaining players must determine how to adapt going forward.
Borrowers, too, face uncertainty as the interest rate resets and payment shocks built into their ARMs take on new significance in this reappraised risk environment. The aftershocks of these sizable collapses could soon lead to significant changes throughout the multi-trillion-dollar industry, with widespread impacts on lenders and the millions of homeowners who have chosen adjustable products.
And in this blog, we’ll look at the impact caused by these bank failures and what it would mean for the ARM industry.
Background of the Bank Failures
In early 2023, two prominent banks failed: Silicon Valley Bank and Signature Bank. Silicon Valley Bank was a major provider of banking services to technology companies, while Signature Bank specialized in commercial banking.
The failures of Signature Bank and Silicon Valley Bank represented two of the largest bank collapses in US history. Specifically, Signature Bank’s downfall marked the third largest, just behind Silicon Valley Bank’s collapse, which was the second largest.
At the time of its failure, Signature Bank held approximately $110 billion in total assets and $89 billion in deposits. Silicon Valley Bank was larger, with around $209 billion in assets and $175 billion in deposits when it collapsed.
For perspective, Washington Mutual Bank, which failed during the 2008 financial crisis, remains the biggest US bank ever to fail. Prior to its seizure and acquisition by JPMorgan Chase, Washington Mutual had roughly $307 billion in assets and $188 billion in deposits — substantially more than both Signature Bank and Silicon Valley Bank.
Their failures introduced stress into the banking sector, as noted by the FDIC in their 2023 Risk Review. As a result, unrealized losses increased to $618 billion in the last quarter of 2022 and $516 billion in the first quarter of 2023.
The FDIC has warned that the banking sector is likely to face more short-term failures, which could significantly impact the ARM industry. Banks may tighten lending criteria and become more selective in who they lend to, which could lead to a decrease in the number of ARM transactions. Additionally, banks may become less willing to provide loans with high leverage ratios, which could reduce the attractiveness of ARM transactions.
Impact on Banks and Asset Quality
The bank failures have introduced more uncertainty into the financial sector. For firms, this means closer monitoring of the banks both they and their clients rely on.
As described in this survey of fund managers, the bank failures have increased scrutiny of banks and caused liquidity concerns. Companies that rely on bank funding could potentially restrict access to working capital lines of credit needed to operate their businesses. Securing financing for accounts receivable factoring or purchase order financing may become more difficult or expensive.
Recent signs of weakening asset quality, like higher past due rates on auto and credit card loans, show underlying risks building in the consumer segment. If the labor market or economy stumbles, delinquencies could surge. Banks may then tighten lending standards rapidly or encounter financial pressures.
Either scenario disrupts payment flows and increases counterparty risk for companies. It is prudent to have contingencies in place with customers to switch banks if needed. Diversifying funding sources beyond banks also protects against over-reliance on any single troubled institution. Rising consumer debt loads make this a precarious time — strong risk management will be essential to protect businesses from potential losses. Companies should also be aware of potential liquidity risks, such as the ability to access short-term funding when needed.
Impact on Consumers and Debt Levels
Combining the bank failures with the recent rise in debt levels and high inflation puts an increased financial strain on households. Even as consumers took on more loans to maintain spending, they had to devote a larger share of wages to pay for necessities.
This leaves households with less flexibility to absorb additional interest rate hikes or economic downturns. The rising debt-to-income ratio shows borrowers have limited capacity for further debt obligations.
As the cost of living continues to outpace income growth, late payments, and defaults may rise across different loan categories in the coming years. This could negatively impact asset quality at financial institutions.
We may see greater demand for receivables factoring or purchase order financing from businesses trying to extend credit terms in response. However, servicing this new wave of consumer debt could become riskier if the economy slowed down. Tighter underwriting will be necessary to focus on borrowers who can still afford obligations when interest rates increase.
Heightened Regulatory Oversight Complicates Operations
Bank failures intensify regulatory focus on risk and compliance across the financial sector. This means the financial health and stability of both client banks and funding partners bear close watch. Any signs of rising NPAs, tightening lending standards, or liquidity issues could signal the development of broader stress.
Contingency plans should cover client bank failures as well as the potential for reduced access to working capital lines or disrupted payment networks. Non-bank funding alternatives may grow in importance to diversify counterparty exposures.
With interconnected linkages across the financial system, problems at one institution may spill over to impact ARM operations. Proactive evaluation of these connections will be critical to weather periods of instability.
Recommendations for Resilience in Unstable Times
In addition to diversifying funding sources and payment networks, it would be wise to:
- Build internal compliance management systems to address oversight systematically
- Engage regulators proactively to shape policy changes with operational realities in mind
- Pursue strategic advisory services to stay abreast of a shifting regulatory landscape
- Consider restructuring business models or operations to preempt overly burdensome requirements
- Benchmark best practices from regulated industries accustomed to compliance obligations
By taking a proactive, preventative approach, firms can minimize disruptions from heightened oversight and capitalize on new opportunities. With advanced planning and adaptive capabilities, the ARM industry can emerge stronger from periods of financial instability driven by bank troubles.