MNI INTERVIEW: Small, Midsize Credit Seizing Up, Says Kaplan

The Federal Reserve should stop raising interest rates as credit to small and medium sized businesses is already freezing up due to turmoil affecting U.S. regional banks, and because the rapid tightening of conditions could prove a long-lasting drag on the economy, former Dallas Fed president Robert Kaplan told MNI.

An aggressive emergency response from the Fed and other regulators has calmed the immediate banking panic, Kaplan said, but lack of clarity over the extent of federal guarantees for depositors – after those at Silicon Valley Bank and Signature Bank were made whole – is keeping smaller lenders on edge.

“While things are calmer and the Fed has given a lifeline to the banks, the cost of this right now is that small and mid-sized credit is pretty much frozen,” Kaplan said in an interview. “Small to mid-sized banks are nervous that the deposit run is calm but they’re nervous that it’s not over.”

Many such banks have few options other than imposing more stringent lending requirements, he said.

“I would say there’s a fragility here and my concern is there’s going to be some scarring. I don’t want to come out of this downturn, if it’s coming, with an impaired credit creating capability for small and medium-sized banks,” Kaplan said. (See MNI INTERVIEW: Financial Stress Could Be In Early Stage-Hoenig)

TIME FOR A PAUSE

Kaplan said last month’s quarter-point Fed hike to 4.75-5% was ill-advised because officials have not yet been able to confirm the full extent of credit retrenchment after weeks of banking turmoil, which included an emergency, government-backed acquisition of Credit Suisse by UBS.

“I would not have raised rates in the last meeting and I probably have the same stance right now,” he said. “I don’t fully understand the fallout yet on small and midsize credit of this situation. My guess is it will take three to four to five months to see the impact of that.

“That would make me much more deliberate because what I don’t want to do is make the situation worse by tightening the tourniquet on small and mid-sized banks by raising their funding costs.”

Kaplan said the Fed’s plans to shrink its USD8.7 trillion balance sheet were effectively nullified by its emergency interventions like the new lending facility to banks.

“Not only are we are not doing QT right now, we’re actually net expanding balance sheet,” he said.

SAND IN THE GEARS

He worries the regional bank crisis will lead to a decline in the number of small and midsize banks, and hamper their competitiveness against larger rivals.

“A lot of people say ‘we’re in a digital world and if you’re a small restaurant in Wichita Falls you can get a loan digitally’ – no, that’s not how it works, you need a local presence, you need somebody who knows you, you need relationships,” Kaplan said.

“You don’t want a situation where big business right now has an enormous advantage over small business. They’ve got public market access, they’ve got bank access. But if you are reliant out of necessity on small and mid-sized banks and you can’t get (a loan) you’re really putting sand in the gears of capitalism.”

Kaplan said Congress might need to raise the FDIC’s USD250,000 deposit insurance limit to alleviate some of this stress.

“I don’t know whether it’s 2 million or 3 million or 4 million, I don’t think it needs to be unlimited. If you raise it you will gobble up a chunk of the issue,” he said. “The banks will still have trouble getting through this but need to worry about a deposit run being one of the reasons. And I’m hoping that will allow the muscles to avoid atrophying in small and mid-sized credit creation.”