Banking crises matter for growth. Policy responses are crucial

The failure of Silicon Valley Bank and other stresses in the global banking system have triggered a sharp repricing in financial markets, with stocks and bond yields sliding. Our baseline assumes a banking crisis will be averted. But some shift in market pricing is not surprising considering that a banking crisis – even if a tail risk – would have very serious consequences for growth.

What you will learn:

• Historically, banking crises tend to hit output hard. Up-front effects can be substantial and lasting damage is also possible – some estimates of the cut to long-term GDP are in the range 5%-10%. Even crises focused on smaller banks can have a substantial negative impact.
• The channels through which banking crises affect economies include: disruption to payments, negative wealth effects, damage to output in the financial sector, and sharply tighter credit conditions for the broader economy – bank share prices are a leading indicator of bank credit standards. Fiscal clean-up costs can also add to the burden via higher long-term interest rates. Our recent modelling captures these kinds of impacts.
• A notable risk area is the effect on lending to commercial property. This can be an important channel even when a banking crisis is focused on smaller banks, such as in the US savings and loans crisis and the UK’s secondary banking crisis. CRE lending could be a problem area today, too, given the already-weak trends in the sector and its concentration in smaller US banks.