Interest rate hike may accelerate bank failures

While the prospect of more bank failures may be alarming, the truth is as long as you’re armed with knowledge and the willingness to act on it, you can still do well even when circumstances are challenging. So let’s examine what is going on right now and decide the best course of action based on facts and not emotions. 

This Wednesday, the Federal Reserve decided to increase interest rates by a quarter point from 5 percent to 5.25 percent.

To be sure, this is likely to produce a variety of negative consequences. By making it more expensive for people to borrow money, higher interest rates tend to slow the economy and hinder job creation. 

This rate increase comes after other bad news for the economy. A recently released report on the US economy’s performance in the past quarter showed that growth had slowed to 1.1% — even more disappointing than economists’ projection of 2% growth.

However, even more concerning than the prospect of a recession is the likely possibility the pace of bank failures could accelerate. Directly prior to the rate increase announcement, the second biggest bank failure in American history occurred with the downfall of First Republic Bank.

Like Silicon Valley Bank, which collapsed in March, the demise of First Republic Bank was linked to rising interest rates. Much of First Republic’s assets were invested in long term loans at low interest rates. Higher interest rates in effect caused these loans to be worth less, ultimately causing the bank to fail. Silicon Valley Bank’s doom was linked to another long term, low interest investment, treasury bonds.

Since SVB and First Republic’s failures were caused in large part by rising interest rates, will more banks collapse? In fact, more bank failures are already underway, and the real question is just will the crisis be containable or will it continue to spread as a contagion with banks failing one after another like dominoes?

Yesterday, regulators halted trading as shares in PacWest and Western Alliance banks plunged. It is likely these two banks will soon join the ranks of this year’s bank failures.

What does all of this mean for you? The increasing likelihood of recession certainly makes the stock market less attractive although even in a recession businesses can survive and even thrive. Businesses like dollar stores and other discounters may do even better as more people try to stretch their money further and you can never underestimate the creativity of many entrepreneurs to adapt to changing circumstances.

High interest rates also bring some major benefits. Annuity sales are surging because higher interest rates have also boosted rates paid by annuities, giving people, especially retirees, the security of guaranteed payments that continue regardless of the stock market, offer tax advantages, and the backing of not a bank, but an insurance company, which may be more stable.

If you have money to lend, higher interest rates can also make lending a more attractive option. Making loans isn’t just for banks anymore, and there are now numerous websites for “peer to peer lending.” You can also regulate your risk level by your choice of whether you want to lend to riskier borrowers or people with impeccable credit.

Many people have opinions about the Federal Reserve and its policies. This is a big issue to solve. However, what we all can agree on and what we all can do right now is be informed on the factors that will impact our money and make smart decisions.