‘Some losses’ in commercial real estate and Treasurys may still need to work ‘through the banking sector,’ says Fed’s Kashkari

Rising interest rates can make it harder to refinance debt for property owners and overall values of debt tied to real estate have slumped, weighing on banks who have exposures. Small banks have become key players in commercial real estate over the past two decades.

The Fed president emphasized that the banking system “is resilient and it’s sound,” but cautioned that the troubles emanating from the banking sector may not be over.

“We know that there are other banks that have some exposure to long-date Treasury bonds, who have some duration risk, as they call it, on their books,” Kashkari said.

He said that current challenges with banks “definitely brings us closer” to recession but warned that it may still be too early to know the impact of troubled banks on the economy.

Kashkari said while large deposit outflows that some small to midsize banks have experienced in recent weeks have slowed, parts of the capital markets “have largely been closed” for weeks.

Last Wednesday, the Fed unanimously voted to raise its benchmark federal-funds rate by a quarter percentage point to a range between 4.75% and 5%, marking its ninth straight increase, and doing so despite lingering concerns about the health of the financial system amid troubles related to major lenders including Silicon Valley Bank, as well as international banks such as Credit Suisse and Deutsche Bank

Rising interest rates have weighed on some lenders, at least partly, because banks are compelled to offer higher interest in the short-term on deposits, even as the interest rates that they collect on longer-term loans aren’t moving up as fast. Rate increases by the Fed are driving yields for short-term debt higher, but fears of economic recession down the road are driving yields, which move opposite to prices, lower.

That dynamic has weighed on the profits for financial institutions.

On top of that, not all banks have been managing risks effectively, with SVB, for example, obliged to sell assets at a loss to meet a deposit exodus.

Investors have been worrying that the failures of SVB and other banks could spread throughout the sector, and parts of the globe, if nervous customers continued to pull deposits from some, mostly smaller, lenders.

See: Emergency borrowing from Fed dips, a sign that bank stress may be easing

Kashkari is a 2023 voting member of the Fed’s rate-setting Federal Open Market Committee.

The Fed president’s comments come days after Fed Chairman Jerome Powell said the Fed remains focused on its fight against rising inflation, even as it acknowledged that the stability of the banking system has been on the Fed’s radar. Forecasts now show the Fed raising rates just one more time this year to a range of 5%-to-5.25% range.

Read: ‘Very unclear’: Powell’s press conference provided more questions than answers. Here are 4 big ones economists still have.

Markets ended last week higher, with the Dow Jones Industrial Average rising 1.2%, while the S&P 500 advanced 1.4% and the Nasdaq Composite Index advanced 1.7%, according to FactSet data. The Dow snapped two straight weeks of losses, while the S&P 500 and Nasdaq each booked back-to-back weekly gains.

Also see: Why the worst banking mess since 2008 isn’t freaking out stock-market investors — yet