A top strategist says ‘massive unrealized losses’ are a ‘Pandora’s box’ for banks and it’s going to impact lending

Regulators and government officials are urging calm in the wake of this month’s major bank failures, while insisting that the U.S. financial and banking system remains stable. But even if the dust is starting to settle after a chaotic few weeks for bank stocks, the crisis may not be over yet as bank assets could still be in trouble, according to some experts.

“Financial stress issues, the liquidity crisis, the bank runs, that can stop. Will the capital issues that the U.S. banking system faces, will that go away? I would argue it doesn’t,” Priya Misra, head of global rates research at TD Securities, said in an interview with Bloomberg Thursday.

With Silicon Valley Bank and Signature Bank depositors protected by the government, and other bank stocks that were extremely shaky a few weeks ago seemingly stabilizing, the more overt contagion fears may have been put to bed. But that doesn’t mean the financial system is safe just yet, as banks are still sitting on trillions of dollars in unrealized losses.

“I think you’ve opened a Pandora’s box; there are massive unrealized losses sitting on bank balance sheets,” Misra said. If banks start running into balance sheet issues and worrying about being in a strong financial position, it could potentially lead to smaller and more expensive loans, sparking the dreaded credit crunch that economists and government officials have been warning about for weeks.

“Either [banks are] going to have to shed assets or raise capital or some combination of both, and that’s going to impact lending standards,” she said.

Unrealized losses are paper losses affecting bank assets that have decreased in price, but have not yet been sold, which would “realize” that the asset has diminished in value. Unrealized losses were one of the culprits behind SVB’s downfall, as the bank possessed large holdings of long-term government bonds that became worth significantly less because of the Federal Reserve’s abrupt shift from near-zero interest rates to a high-rate environment over the past year. SVB announced it was expecting a $1.8 billion loss on sales of its investments in early March, a catalyst behind the bank run that eventually led to the bank’s collapse.

SVB was plagued with mismanagement issues before failing, including lacking an official chief risk officer for the eight months before its collapse. But many, if not most, other banks could be facing similar issues. Unrealized losses at U.S. banks may have totaled as much as $1.7 trillion by the end of last year, according to a New York University paper published this month.

Misra said tighter lending standards are likely to have an impact on the economy, but the unknown is when that will happen and which markets and sectors will be hardest hit. It could all add up to a higher likelihood of a recession hitting soon, aggravated by the rapidly shrinking pool of consumer savings that has been Americans’ guardrail against a recession for months, Misra added.

“That savings buffer is running down. This is exactly when banks should be making loans. And if the banks are actually stepping back I think it adds to the monetary tightening,” she said, adding that the combination of circumstances is “absolutely going to result in a hard landing” for the economy.

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