Emerging Threats to Financial Stability: Nonbank Financial Institutions and Commercial Real Estate
Paper Session
Saturday, Jan. 4, 2025 2:30 PM - 4:30 PM (PST)
- Chair: Stijn Van Nieuwerburgh, Columbia University
Monetary Tightening, Commercial Real Estate Distress, and US Bank Fragility
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.The Nonbank Footprint of Banks
Abstract
At least 10% of aggregate nonbank financial institution (NBFI) assets are held within bankholding companies (BHCs), with peaks in specific segments between 50% and 75%. We argue
that the coexistence of commercial banks and NBFIs within BHCs can be partially explained by
synergies related to liquidity management. Using intercompany transfers, diversified BHCs can
economize on liquid asset holdings by redistributing cash between bank and nonbank business lines that experience relatively uncorrelated liquidity outflows. Using a unique database on BHC organizational structures, we show empirically that banks with larger nonbank affiliates hold less cash on their balance sheets. We show that our results are driven by explicit and implicit intercompany funding arrangements between affiliated banks and nonbanks, and that regulation can be an important factor in driving BHCs’ organizational structure decisions.
Shadow Always Touches the Feet: Implications of Bank Credit Lines to Non-Bank Financial Intermediaries
Abstract
We document a new channel of risk transmission from the real estate market to the banking sector through the provision of liquidity insurance by banks to financial institutions. Using credit lines to Real Estate Investment Trusts (REITs) as a laboratory, we show that these linkages pose a major systemic risk to the banking sector. We find that drawdown rates of REITs are higher than the ones of non-financial borrowers and more sensitive to aggregate, as well as sector-specific market stress. This translates into higher tail risk and lower stock market returns for banks more exposed to REITs. Surprisingly, banks do not price these risks and offer cheaper credit lines to REITs than to other borrowers. Our results highlight an alternate channel through which the recent stress in commercial real estate markets affects banks.Discussant(s)
Andra Ghent
,
University of Utah
Matteo Crosignani
,
Federal Reserve Bank of New York
Yiming Ma
,
Columbia University
Rodney Ramcharan
,
University of Southern California
JEL Classifications
- G2 - Financial Institutions and Services
- G1 - General Financial Markets