Yellen reassures bankers ahead of Fed meeting: ‘The situation is stabilizing’

Treasury Secretary Janet Yellen said Tuesday that the period of turmoil in the financial sector following the failures of several large banks may be coming to an end.

“The situation is stabilizing,” she said Tuesday at a conference of the American Bankers Association, the largest trade group for U.S. banks, in Washington, D.C.

As evidence, Yellen cited increased lending to banks from the Federal Reserve, including from a new line of credit that was set up by the Fed and backstopped by taxpayer money. She also said that flights of deposits out of smaller banks to the banks that were deemed “too big to fail” in the wake of the global financial crisis of 2008 have calmed down.

“The Fed facility and discount window lending are working as intended to provide liquidity to the banking system. Aggregate deposit outflows from regional banks have stabilized,” she said.

The Fed added more than $300 billion to its balance sheet over the last week, nearly halving the program of quantitative tightening that it began along with its interest rate hikes in March 2022.

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Whether this will have a stimulative effect on the economy and add to inflation, or whether all that money is simply keep banks solvent, remains to be seen.

Yellen struck a diplomatic tone in regard to smaller banks, who denounced her statements to Congress last week about which banks are eligible to have their deposits insured over the standard $250,000 account limit.

That exception is made only if “the failure to protect uninsured depositors would create systemic risk and significant economic and financial consequences,” Yellen told Congress last week.

“Large banks play an important role in our economy, but so do small and midsized banks. These banks are heavily engaged in traditional banking services that provide vital credit and financial support to families and small businesses,” she told bankers on Tuesday.

The current banking crisis has had three main acts so far.

The first involved a public rescue of the $212 billion SVB and Signature Bank orchestrated by the FDIC, Fed and Treasury. The second was a $30 billion private-sector bailout of California-based First Republic Bank by a consortium of 11 larger banks, and the third was the flash sale of Credit Suisse to competitor UBS brokered by the Swiss government.

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The initial failure of SVB, which set off the wider crisis, was caused by poor risk management of the bank’s portfolio, which was heavily invested into longer term securities that are sensitive to increasing interest rates.

“There needs to be a lot more rigor around the counting of securities that banks say they’re going to hold to maturity, but don’t really have the capacity to do it, as we saw with Silicon Valley,” former FDIC chair Sheila Bair said on CNBC last week.

“These banks need to have interest rate risk stress tests. This is the new issue. This isn’t a credit problem. It’s an interest rate risk problem. This is the issue now confronting all banks. There are ways to hedge your interest rate risk, but examiners and managers need to get stress [tested],” she said.

Yellen on Tuesday said that the current bank regulatory regime needs to be reconsidered.

“We will need to reexamine our current regulatory and supervisory regimes and consider whether they are appropriate for the risks that banks face today,” she said.

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