The effect of a banking crisis on monetary policies

We look at the possible effect of the US regional bank ing crisis on the monetary policy conducted by the Federal Reserve and the ECB. This crisis has pushed up yields on bonds issued by banks, which normally curbs the supply of bank lending. To offset this slowdown in credit supply, central banks can adopt lower key interest rates than in the absence of a crisis. The historical relationship between yields on bonds issued by banks and the Fed Funds rate in the United States is that a 100 basis point increase in the credit spread on bank bonds (subordinated or senior) leads to a 69 to 75 basis point fall in the Fed Funds rate. In the euro zone, a 100 basis point increase in the credit spread on senior bank bonds leads to a 94 basis point fall in the repo rate and a 100 basis point increase in the spread on subordinated bank bonds leads to a 26 basis point fall in the repo rate. Applied to the widening of spreads on banks’ subordinated bonds since the start of the banking crisis in March 2023, this estimate leads to an assumption of a 60 basis point reduction in the Federal Reserve’s terminal rate and a 30 basis point reduction in the ECB’s terminal rate.