Fearing a credit freeze, Fed gives big banks new tools to keep lending taps open
As Main Street begins to take stock of the economic damage caused by the current coronavirus-related lockdown, Wall Street’s eyes are on the big banks—and the measures taken by the Federal Reserve and other government entities to ensure that they stay liquid and functional.
This week has seen the Fed spring into emergency action to ensure major financial institutions are equipped to weather the headwinds. The big Wall Street banks now are taking advantage of an expanded 90-day “discount window” to borrow from the central bank, while Tuesday saw the Fed relaunch a recession-era credit facility for lenders and a commercial paper facility to provide lending to businesses.
The idea is to ensure that as the U.S. economy almost certainly gets worse in the coming months, American companies are able to borrow the money they need in order to continue operating and keep workers on the payroll. Thus far, the federal government has taken measures to ensure that is the case; in addition to the Fed’s measures, the Treasury Department’s Office of the Comptroller of the Currency is reportedly considering loosening leverage restrictions on banks.
That’s good news, because a lot of borrowers are expected to need help. Companies like Boeing, AB InBev, and Kraft Heinz are already drawing down billions of dollars of credit from their lenders as the coronavirus disrupts nearly every corner of the economy. There are also fears that the massive amount of triple-B-rated debt on the corporate bond market could cause trouble if those notes are downgraded to junk.
According to banking and capital markets consultant Mayra Rodriguez Valladares, it’s important that the banks are “well prepared” and “sufficiently liquid” when corporate borrowers rush to draw on their credit facilities.
“That’s where the danger is this time; in the run-up to the [financial] crisis, it was leveraged households, and now it’s leveraged corporations,” Valladares says. “Many of these companies have continued to get more levered…You can expect a cascade of [corporate bond] downgrades.”
In the meantime, some banks may find themselves taking advantage of current dynamics to drive business. Speaking on CNBC on Tuesday, Truist CEO Kelly King noted that mortgage applications have been “off the charts” amid a lower interest rate environment in recent months, with the bank’s mortgage volumes having “quadrupled in the last two to three months.”
Of course, near-0% interest rates are generally a headwind for banks, given how they compress the margins that financial institutions are able to make through net interest income. But at least the heavy losses and extreme volatility seen in the stock markets in recent weeks have had the effect of boosting trading volumes and activity for many banks.
“Trading volumes are through the roof,” notes Brad Bailey, a research director in the capital markets division at financial consultancy Celent. “The [banks’] transactional businesses are doing well; you think about all the volatility and the trading taking place, and everyone becomes very reliant on people who know what they’re doing…It’s a big boost for most firms.”
That won’t be very comforting to Main Street investors who fear checking their 401(k) accounts in the midst of this month’s historic selloff. But if the banks keep functioning as intended, it should help many businesses weather the ongoing storm—and in the process, mitigate the impact on the lives of average working Americans.
More must-read stories from Fortune:
—How to prepare your personal finances for a coronavirus recession
—The Fed made a bold move to calm shaky markets. But is it enough?
—Why return CEOs are usually bad news for a company’s stock
—Dormant PayPal Credit accounts are coming back to hurt credit scores—Listen to Leadership Next, a Fortune podcast examining the evolving role of CEOs
—WATCH: What’s causing the looming recession
Subscribe to Fortune’s Bull Sheet for no-nonsense finance news and analysis daily.