Can FRC Collapse Affect Forex Markets?

Markets turned lower through the week as investors are once again worried about a liquidity crisis among US regional banks. The space had calmed down over the last couple of weeks, as no new bad news allowed investors to focus elsewhere. But, on Monday First Republic Bank (FRC) reported earnings, and subsequently dropped 50%, dragging the index with it.

Back when the SVB crisis was in full swing, FRC was seen as the next potential domino to fall. It had a similar problem, with a large number of uninsured depositors that were withdrawing money. Unlike SVB, it didn’t have a large holding of US treasuries and MBS. On the one hand, it meant it wasn’t dealing with a large amount of unrealized losses due to the higher interest rates. On the other hand, it meant it couldn’t opt into the new Fed BTFP program.

Falling through the cracks

The original cause of the banking crisis was that high interest rates were causing Treasuries to decrease in value. That meant banks were experiencing “unrealized losses”. That is, they had treasures that if they tried to sell, would be worth less than their value. That wouldn’t be a problem for banks, since they could hold them to maturity. But, if a bunch of people decided to withdraw funds, then the bank would need liquidity and beforeced to “realize” the losses on their treasuries by selling them. That’s what precipitated the collapse of SVB.To fix this problem, the Fed implemented a program (BTFP) that would allow banks to borrow money using these undervalued treasuries. That means they could pay out depositors even if their Treasury holdings were worth less than face value. This effectively put an end to major worries for the banking system, since the original cause of the crisis was eliminated.

Is being unique a good thing?

By that point, however, FRC had already seen a substantial amount of depositors withdraw money as part of a general move of moving money out of smaller banks. FRC didn’t have the same problem; they hardly had any Treasury holdings. Which means they couldn’t turn to BTFP like other smaller banks. With FRC in the news, more people were prompted to withdraw their money, creating a crisis of confidence that precipitated a run on the bank.

On Monday, FRC reported their earnings, disclosing that over 40% of deposits had been withdrawn. The bank still managed to report a profit, because the source of income remained intact. It was just having severe difficulties meeting the demands of depositors. The price of its stock cratered again, and people wondered if there would be another round of banking contagion.

The bottom line

Other banks are not in a similar situation to FRC, in that they can cover all their collateral holdings with the Fed. So, direct contagion isn’t particularly likely. But another bank collapsing would likely worry investors again, and cause another round of risk-off trading until the situation stabilized.

“Indirect contagion” could become the next problem. If FRC were to go into receivership, it would mean that the FDIC funds might be depleted, forcing banks to pay into it to balance the banking system. This increased cost of operation for banks could strain other small banks. And it would also likely lead to banks being even more unwilling to give out loans, slowing the economy further. This could once again affect the dollar, if the Fed is forced to support banks once again, and ease up on monetary policy tightening.

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• Source: https://www.orbex.com/blog/en/2023/04/can-frc-collapse-affect-forex-markets