As the 2008 financial crisis threatened to collapse the global economy, governments around the world stepped in to rescue struggling banks deemed “too big to fail.” This extraordinary intervention raised concerns that large financial institutions could expect taxpayer-funded bailouts in the future, potentially subsidizing their reckless behavior and shielding them from the costs.
In a paper in the American Economic Review, authors Antje Berndt, Darrell Duffie, and Yichao Zhu provide evidence that instead of increasing after the Global Financial Crisis, market expectations of a government bailout for globally systemically important banks (GSIBs) actually decreased.
They drew their results from a structural model of bank valuation, unlike previous studies of bank bailouts which used reduced-form methods. The authors calibrated their model using financial statements and market prices of debt, equity, and equity options for six major US GSIBs, including Bank of America, Citigroup, Goldman Sachs, JP Morgan Chase, Morgan Stanley, and Wells Fargo.
Figure 3 from the authors’ paper shows their estimates of the “no-bailout” probability—the probability that GSIBs would not be bailed out by the government if they became insolvent—between 2001 and 2023.
The dark blue line represents the estimated no-bailout probability for each month, while the shaded light blue area indicates the range between the fifth and ninety-fifth percentiles of the bootstrap distribution of this probability, indicating the statistical confidence in the estimates. The gray vertical bands indicate recessions.
The chart depicts a dramatic and persistent increase in no-bailout probabilities after the 2008 global financial crisis. Prior to the crisis, markets implied only about a 5 percent chance that these massive banks would not be rescued if they approached insolvency. After the crisis, this probability jumped to around 10 percent, eventually climbing to as much as 20 percent.
This shift in bailout expectations aligns with post-crisis regulatory reforms, including the Dodd–Frank Act’s establishment of new insolvency resolution mechanisms aimed at forcing creditors, rather than taxpayers, to bear losses when large banks fail.
The authors’ model still implies a high probability, roughly 87 percent on average, that GSIBs will be bailed out. But their research provides some quantitative evidence that too-big-to-fail distortions in the US banking system have moved in the right direction.
The eruption of tariff wars between the United States and its key trading partners has introduced significant economic instability and financial volatility. As trade disputes continue to evolve, American banks, traditionally considered resilient pillars of the financial sector, are facing a unique set of challenges that could threaten their operations and future growth. This article explores the multifaceted impacts of tariff wars on American banks, including how these institutions are grappling with market fluctuations, currency volatility, increased costs, and shifting consumer behaviors. The article also examines potential policy responses and the long-term implications for financial markets and economic growth in the U.S.
Introduction
The term “tariff war” became a central theme of global trade discussions after the United States imposed tariffs on various imported goods, primarily from China, but also targeting other nations such as the European Union, Canada, and Mexico. While the immediate effect of such tariffs has been felt across industries ranging from manufacturing to agriculture, their impact on the financial sector, especially American banks, has been profound. For decades, U.S. financial institutions have been largely insulated from the direct impacts of global trade tensions. However, the ongoing tariff war has exposed the vulnerabilities of American banks, as their business models are increasingly intertwined with global markets.
This article examines the ways in which U.S. banks have been directly and indirectly affected by the tariff war, analyzing the economic disruptions, financial volatility, and the broader implications for their stability. Through a combination of quantitative data and qualitative insights, the research assesses how these institutions are adjusting their strategies to cope with an increasingly unpredictable global economic environment.
Impact on American Banks
- Market Volatility and Financial Instability One of the most immediate impacts of the tariff war has been the surge in market volatility. Tariffs introduced by the U.S. government and retaliatory tariffs imposed by trading partners have resulted in dramatic fluctuations in stock prices, foreign exchange rates, and commodity prices. American banks, particularly those with significant exposure to international trade, have faced challenges in managing this volatility. The uncertainty caused by shifting trade policies and the lack of clarity regarding future tariff levels have resulted in fluctuating investor sentiment. As a result, American banks have witnessed increased fluctuations in their stock prices, with some institutions experiencing significant declines due to their exposure to global markets. Additionally, fluctuations in foreign exchange markets have caused increased risk for banks operating internationally. The value of the U.S. dollar, impacted by changing trade relationships, has seen a degree of instability, leading to increased hedging costs and a potential loss of revenue for banks engaged in cross-border financial transactions.
- Rising Operational Costs In response to higher tariffs on imported goods, businesses in the U.S. have faced rising costs. These rising costs have trickled down to the financial sector, increasing operational expenses for American banks. While the financial services industry may not directly deal with tariffs on physical goods, the higher costs borne by corporate clients often result in reduced lending demand or defaults, especially in industries heavily reliant on imports and exports. Banks with large portfolios of commercial loans in manufacturing and retail sectors are particularly vulnerable. The rising costs associated with goods and services are being passed on to these businesses, which in turn raises the risk of loan defaults. Moreover, as businesses face higher operational costs, they are forced to reevaluate their expansion plans, reducing borrowing activity and slowing down economic growth—further impacting financial institutions.
- Credit Risk and Loan Performance The fallout from tariff wars has exacerbated credit risk for banks, particularly those that have substantial exposure to companies in sectors such as agriculture, automotive, and technology. In response to the tariff hikes, many businesses are adjusting their supply chains, shifting production to other regions, or cutting back on expenditures. This has led to increased risk in the form of loan defaults, delayed payments, and business closures. For American banks, this presents a significant challenge to their credit portfolio management. As credit losses rise, the banks must adjust their risk models to account for this heightened uncertainty. In addition, increased borrowing costs for businesses due to tariffs lead to tighter financial conditions, which may hinder the ability of certain companies to repay loans.
- Shifting Consumer Behavior The tariff war has also had an indirect impact on American consumers, leading to changes in behavior and demand for banking services. As prices for imported goods rise due to the increased tariffs, consumer purchasing power is diminished. This, in turn, affects the overall economy, slowing down spending and potentially leading to a reduction in demand for consumer credit. Furthermore, as consumers face financial pressure, there is an increased reliance on credit cards and personal loans, putting a strain on banks’ ability to maintain healthy debt-to-equity ratios. With declining consumer confidence, American banks may also face challenges in maintaining profitable lending practices, especially in the retail banking sector.
Policy Responses and Bank Adjustments
In response to the economic challenges posed by the tariff war, American banks have had to make several strategic adjustments. Central banks, including the Federal Reserve, have taken steps to mitigate the negative effects of the crisis by lowering interest rates, providing liquidity support, and engaging in market interventions. U.S. banks, particularly large institutions, have been able to take advantage of these low-interest rates to manage liquidity risks and cushion the impact of reduced profitability.
On the institutional side, many banks have focused on diversifying their portfolios to mitigate risks. Some have sought to reduce exposure to specific industries that are directly impacted by tariffs, such as manufacturing or agriculture. Others have increased their focus on wealth management and investment banking, which are less directly affected by the volatility in global trade.
However, the tariff war continues to pose significant challenges for American banks. As trade disputes evolve and the global economy becomes more unpredictable, it is likely that financial institutions will continue to adapt their strategies, balancing risk management with growth initiatives.
Conclusion
The ongoing trade war has forced American banks to confront a new set of challenges, exposing vulnerabilities that were previously hidden within the global financial system. With the uncertainty surrounding trade policies, banks must adopt new strategies to safeguard their profitability, mitigate risks, and manage the volatility in global markets. The long-term effects of the tariff war on American banks remain to be seen, but it is clear that the financial sector must evolve to cope with the growing economic instability.
As geopolitical and trade tensions persist, American banks will need to remain agile and responsive, adjusting their policies and risk assessments to ensure long-term stability. Whether through diversifying their portfolios, adjusting to consumer behavior, or engaging in policy advocacy, these institutions will continue to play a crucial role in the U.S. economy as they navigate the complex landscape of a post-tariff world.