Morgan Stanley: New Banking Rules Will Make Credit Standards Even Tighter

By Vishwanath Tirupattur, global head of Quantitative Research at Morgan Stanley

It has been an eventful week. The much-debated resolution of First Republic finally materialized, but investor angst around regional banks persisted, resulting in a week of losses – the KBW Bank index had fallen 11% for the week by Thursday. While the resolution was clearly “an important step toward drawing a line” under banking sector volatility, to quote Fed Chair Jerome Powell, investor fears have not dissipated, with concerns now focused on regional banks’ capital and operating models. The collapse of four US banks in the last few months with over US$500 billion in combined assets is hard to dismiss, especially in the context of a slowing economy, reined in by policy rates that have risen sharply over the last year and capped by this week’s 25bp hike. While the Fed has not signaled the direction of its next move, it "won't cut rates" this year if inflation is in line with its outlook, implying a conditional pause that our economists expect to be lengthy.

In the short term, we will monitor the evolution of borrowings from the different Fed facilities to gauge the extent of liquidity stress in the regional banks. While borrowings from the Fed’s discount window fell from US$74 billion a week ago to US$5 billion, mainly due to the First Republic resolution, loans from the Bank Term Funding Program (BTFP) declined only slightly, to US$76 billion. To provide some context, comparable borrowings by the banking system during the Covid crisis peaked at US$51 billion. That the banking system continues to borrow at such high levels suggests that liquidity pressures for regional banks are lingering.