Fed Further Increasing Interest Rates May Worsen US Banking Crisis, Prof Warns

The Federal Reserve should take a wait-and-see approach instead of going for further interest rate hikes after the US banking system was hurt by the Silicon Valley Bank's collapse, Fabrizio Carmignani, a professor of economics and dean at Griffith Business School, Australia, told Sputnik.

The federal takeover of the Silicon Valley Bank (SVB) last Friday has shaken expectations about the Federal Reserve's forthcoming March 22 interest rate decision. While markets are bracing for the Fed's new inflation-fighting effort, Goldman Sachs analysts believe that the central bank will not raise interest rates at all this month.

"It seems to me that there is a scope for the Fed to take a pause before increasing the interest rate again. It's a complicated situation," said Carmignani. "The increase in the interest rate would probably worsen the banking crisis, or at least the potential banking crisis that could be triggered by the events happening with SVB. So it seems to me that even if fighting inflation is a priority, there is at the moment another priority, which is ensuring stability in the financial system, sending a signal to the financial system. And that signal would be compromised, at least to some extent, if the Fed were to increase the interest rate. My expectation is that they will not do that. And if they don't, I think it would be a fair decision."

The US banking system suffered a serious blow last week with the largest bank failure since the financial crisis of 2008. The collapse of SVB has prompted fears of contagion, especially given that US regulators proceeded to close the New York-based Signature Bank two days later. Joe Biden's decision to shield depositors while leaving investors and shareholders out in the cold has prompted a lot of uncertainty throughout the system.

"The type of response that we are observing at the moment in the United States could be defined, in my opinion, as sort of midway between a full bailout and no intervention at all," explained Carmignani.

"By full bailout, I mean something similar to what happened in 2008 when essentially the administration put in place significant interventions to rescue, save, bail out some of the big financial institutions. That bailout, of course, came at a significant cost to taxpayers. At the same time, I would argue that it was necessary because the extent of the financial contagion was such that the implications of not doing the bailout on the economy could have been even worse than the cost of the bailout itself."

The SVB collapse has been largely blamed on the Fed's aggressive hikes, but the professor of economics does not think that the US central bank is directly responsible for what's happening with the California bank.

It was rather the consequence of a chain of events that has been triggered by the increase in the interest rate. Thus, the value of the Treasury bonds that SVB had in its balance sheet has declined and the borrowing costs curbed the Silicon Valley's business activity which caused at least part of the unfolding problem," according to Carmignani. But on the other hand, the increase in the interest rate was inevitable, he underscored.

"One cannot blame the Federal Reserve for that increase. Obviously, as always, in a financial crisis, there are possible lessons that we can learn around regulation and around the role of regulators; and that's probably what we should focus on as we see this crisis unfolding," the academic concluded.