Monetary Tightening, Commercial Real Estate Distress, and US Bank Fragility

62 Pages Posted: 19 Apr 2023 Last revised: 23 Nov 2024

See all articles by Erica Xuewei Jiang

Erica Xuewei Jiang

University of Southern California

Gregor Matvos

Northwestern University - Kellogg School of Management

Tomasz Piskorski

Columbia University - Columbia Business School, Finance

Amit Seru

Stanford University; European Corporate Governance Institute (ECGI)

Date Written: April 4, 2023

Abstract

We analyze the impact of credit risk and higher interest rates on U.S. bank solvency, expanding on the work of Jiang et al. (2023). Our variation of their bank-run model demonstrates how credit losses and asset declines from higher interest rates can trigger self-fulfilling solvency runs, even when banks hold fully liquid assets. Banks with high credit losses, greater exposure to interest rate increases, low capital, and high uninsured leverage are particularly vulnerable. Focusing on 2022’s monetary tightening, we assess banks’ exposure to commercial real estate (CRE) loans, which represent about 25% of average bank assets, totaling $2.7 trillion. Loan-level data shows that, after property value declines from rising rates and the shift to hybrid work, 14% of all CRE loans and 44% of office loans are in negative equity (i.e., property values are below outstanding debt). Additionally, 43% of all CRE loans and 64% of office loans may face cash flow and refinancing issues. A 10% (20%) default rate on CRE loans could lead to $80 billion ($160 billion) in additional bank losses. Had CRE distress occurred in early 2022, when the 10-year Treasury yield was around 2%, no banks would have faced failure, even in pessimistic scenarios. However, by 2024, after substantial asset declines, CRE distress could put dozens to over 300 smaller regional banks at risk of solvency runs. We also find evidence that banks, particularly those facing higher solvency risks and lenient state oversight, have concealed credit losses through “extend-and-pretend” practices. Overall, given the composition of bank balance sheets in Q1 2022, higher interest rates pose a greater threat to U.S. banks than credit risk, potentially constraining monetary policy.

Keywords: Monetary Tightening, Uninsured Depositors, Runs, Commercial Real Estate, Extend and Pretend, Solvency Run

JEL Classification: G2, L5

Suggested Citation

Jiang, Erica Xuewei and Matvos, Gregor and Piskorski, Tomasz and Seru, Amit, Monetary Tightening, Commercial Real Estate Distress, and US Bank Fragility (April 4, 2023). Available at SSRN: https://ssrn.com/abstract=4413799 or http://dx.doi.org/10.2139/ssrn.4413799

Erica Xuewei Jiang

University of Southern California ( email )

701 Exposition Blvd, HOH 431
Los Angeles, CA California 90089-1424
United States

Gregor Matvos

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

Tomasz Piskorski

Columbia University - Columbia Business School, Finance ( email )

3022 Broadway
New York, NY 10027
United States

Amit Seru (Contact Author)

Stanford University ( email )

Stanford, CA 94305
United States

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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