After First Republic’s collapse, what’s next for the U.S. banking sector?

Three bank failures in less than two months

At the start of May, First Republic Bank—which had over USD 200 billion in assets—was bought out by JPMorgan in a government-backed move, following a severe bank run. This mirrored the failures of fellow regional lenders SVB and Signature Bank in March. A large fall in the value of First Republic’s low-interest mortgage portfolio and reliance on a small number of wealthy customers with deposits above the insured limit of USD 250,000 proved to be a lethal combination.

New regulations

Recent banking turmoil is likely to lead to changes to deposit insurance, with the Federal Deposit Insurance Corporation recently calling for the USD 250,000 limit to be raised for certain accounts to prevent depositor flight. In the medium term, stronger regulatory oversight of smaller banks is also possible; however, Congress’ current focus on the debt ceiling and Republican control of the House of Representatives could complicate any such changes this year and next.

Banking consolidation

The U.S. has well over 4,000 small banks, many serving a certain geographical area or specific community. This is a higher number than any other country, and more than the entire EU—despite the latter’s far larger population and more fragmented internal market. More banks are likely to get into financial trouble going forward due to an expected economic slowdown, elevated interest rates and customer jitters; others could seek pre-emptive mergers in order to bolster their solidity—in the last few days, PacWest and Western Alliance have both purportedly considered sales, for instance. And tougher future regulations could further boost the attractiveness of tying the knot with a partner. As a result of all these factors, conditions are ripe for banking-sector consolidation; Nomura’s Greg Hertrich expects only half of banks to survive the next decade.

Fed pause

First Republic’s collapse increases the chance of the Fed leaving interest rates at their current level of 5.00%–5.25% going forward, as ensuing tighter credit conditions will reduce the need for further hikes. Indeed, most of our panel of expert analysts see rates unchanged ahead, although some still expect 25–50 basis points of extra tightening.

Insights From Our Analyst Network

On the importance of recent bank collapses, EIU analysts said:

“The failures are significant; together, the three institutions—First Republic, Silicon Valley Bank (SVB) and Signature Bank—had more assets, adjusted for inflation, than all the 25 US banks that collapsed at the height of the global financial crisis in 2008.”

On rates, Nomura analysts said:

“We think that tighter credit conditions will ultimately weigh down inflation. Against this backdrop, we expect that the Fed will likely be in wait-and-see mode for some time to assess the impact of financial stress in the banking sector, unless core inflation re-accelerates.”