Tariffs Threaten Double Blow to Small US Banks

Inflation and weak growth are a bad mix for anyone, but especially for banks and even more so for smaller US banks still carrying heavy losses on fixed-rate bonds. President Donald Trump’s attacks on global trade and his deficit-boosting budget are on course to expose just how painful this combination could be and to revive a problem that many thought lenders had dealt with.

Unrealized losses on Treasuries and mortgage bonds became a big worry for lenders during 2022 and 2023 when sharp interest-rate rises helped to spark a handful of failures led by Silicon Valley Bank. Now, bond yields are rising again as fears of a recession grow, too. Market-value losses on securities combined with real hits from commercial property debt or small-business loans would be nasty.

There are plenty of reasons to worry about the economic outlook for the US after the House Budget Committee advanced Trump’s tax-cutting bill on Sunday and Treasury Secretary Scott Bessent renewed tariff threats against uncooperative trading partners. Treasury yields have been highly volatile since the start of April and reversed most of the gains for US government debt over the first quarter this year.

The value of unrealized losses on banks’ bond holdings likely reduced in the three months to the end of March, although industrywide data isn’t yet available. They’d worsened over the fourth quarter of 2024 to a total of $482 billion, up by $118 billion since the end of September, according to the latest quarterly data from the Federal Deposit Insurance Corp.

For larger banks, these underwater assets aren’t a problem partly because the losses are a small hit to their overall balance sheets, but to smaller lenders they can be more significant. Regional banks, small banks and community banks account for nearly half these losses collectively, according to a new analysis published by the Treasury’s Office of Financial Research on Friday.

Most of the losses being carried by banks are on residential mortgage-backed securities, which have longer maturities – 15 years or more – than Treasuries and other bonds that banks own. RMBS account for nearly half of banks’ securities holdings but about three-quarters of their unrealized losses. However, the pain from these holdings will be most keenly felt when combined with other potential hits, such as a surge in commercial real estate loan losses, the OFR found.

“While unrealized securities losses alone may not have a direct impact on banks, they could amplify vulnerabilities when banks face stress and increase the chance of lack-of-confidence runs for some banks,” Jose Maria Tapia and Hashim Hamandi of the OFR wrote.

US consumers are still spending at a relatively healthy rate even though confidence is deteriorating, JPMorgan Chase & Co.’s head of consumer and community banking, Marianne Lake, told investors on Monday. Her boss, Chief Executive Officer Jamie Dimon, however, said markets were too complacent about the possibility of stagflation and said that credit was a bad risk currently.

Smaller lenders came under heavy pressure two years ago when the mark-to-market losses they were carrying on their balance sheets got close to or surpassed the amount of equity capital they had. This made uninsured depositors nervous and sparked rapid runs at several lenders, including SVB, Signature Bank and First Republic Bank.

Large lenders were less vulnerable partly because they have to deduct from their capital the unrealized losses on bonds that are held in trading portfolios. That means depositors are far less likely to wake up one day and spot a previously unseen hole in their bank’s balance sheet.

The Federal Reserve helped to end the 2023 mini-crisis by creating a special program to lend cash to vulnerable banks against the full face-value of their bonds – rather than the lower market value – the so-called Bank Term Funding Program.

If the White House policies make stagflation a reality, Trump will end up relying on the Fed to bail out smaller lenders – and his presidency – with a similar program. He might want to think twice about hounding Fed Chair Jerome Powell.

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This column reflects the personal views of the author and does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Paul J. Davies is a Bloomberg Opinion columnist covering banking and finance. Previously, he was a reporter for the Wall Street Journal and the Financial Times.

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