U.S. Bank Fragility to Credit Risk in 2023: Monetary Tightening and Commercial Real Estate Distress

Abstract: Jiang et al. (2023) find that following recent monetary tightening the U.S. banking system’s market value of assets is $2.2 trillion lower than suggested by their book value, accounting for loan portfolios held to maturity. We illustrate that this decline in banks’ asset values has eroded their ability to withstand adverse credit events – focusing on commercial real estate (CRE) loans that account for about quarter of assets for an average bank ($2.7 trillion of bank assets in the aggregate). A 10% (20%) default rate on CRE loans – a range close to what one saw in the Great Recession on the lower end -- would result in about $80 ($160) billion of additional bank losses. While these losses are an order of magnitude smaller than the decline in bank asset values associated with a recent rise of interest rates, they do impact a non-trivial set of banks: an additional 280 (579) banks with aggregate assets of $700 billion ($1.2 trillion) would have their marked to market value of assets below the face value of all their non-equity liabilities. We again focus on uninsured leverage (i.e., Uninsured Debt/Assets) as the key to understanding whether these losses would lead to some banks in the U.S. becoming potentially insolvent--unlike insured depositors, uninsured depositors stand to lose a part of their deposits if the bank fails, potentially giving them incentives to run. Even if only half of uninsured depositors decide to withdraw, the losses due to CRE distress would result in additional 21 (58) smaller regional banks at a potential risk of impairment to insured depositors.

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