This week in the news

Tuesday 8/8/2023:

• Moody’s downgraded the credit rating on 10 US banks and lower the outlook for 11 more (meaning these 11 are under review for possible downgrades). Banks officially downgraded include small and mid-sized banks such as M&T, Pinnacle, and Webster Financial. Major lenders with lowered outlooks include Bank of New York Mellon, US Bancorp, State Street, Truist, and Northern Trust. Moody’s cited “interest rate and asset-liability management (ALM) risks with implications for liquidity and capital”. Increasing interest rates generally mean that existing assets on banks balance sheets become riskier, compounded with the fact that the banks themselves are seen as riskier due to ALM issues.

  • Asset-liability (mis)management is a significant concern for bank stability during periods of rising interest rates. Banks operate by issuing loans and holding other interest-bearing assets, while paying out interest on deposits and other liabilities. In a rising interest rate environment, the bank is receiving low interest payments on all the loans issued and assets obtained during a time of low interest rates, but now it has to pay out higher interest on deposits and other instruments, creating a lower income-higher expense problem. Imagine you are a bank and you issued loans at 4% and paid 1% to deposit customers, that’s a profit (“spread”) of 3%. Say interest rates increase and you have to pay 5% to depositors. You still have all those 4% loans on your books, so you are taking a 1% loss (“negative spread”) on all those previously issued loans.

• China reported that exports dropped by 14.5% a troubling sign for one of the most important economies in the world. This follows recent data showing slowing growth and rising youth unemployment. Unlike the US and Europe, which are battling high prices, China actually cut interest rates this year and is battling deflationary concerns (falling prices, the opposite of inflation). There are concerns globally about China’s debt problems and the lack of demand for the Chinese yuan. When deflation happens, growth becomes even harder, because consumers are incentivized to hoard and save cash instead of spending it.

Monday 8/7/2023:

• PayPal (PYPL) to launch the first USD-backed stablecoin from a major financial institution. The goal is to reduce friction in payments (make it easier to pay for things). Typically a stablecoin would allow users to easily transact within an ecosystem, for example fellow PayPal users could send the stablecoin to each other faster than they could move actual dollars. Being backed by and pegged to the US dollar means the coin is intended to track the value of the dollar, to make it as close as possible to using dollars, only more efficient. And users could convert it to dollars on-demand. The idea of stablecoins sits in a tricky place - they are more likely to be adopted by financial institutions like banks because they have the stability of the dollar, but they remove a defining feature promoted by cryptocurrency enthusiasts - a digital alternative to dollar commerce.