Like I noted yesterday, there’s no way an U.S. president could sign a ceasefire, which would be a de facto capitulation (or surrender). Thus, I don’t think there will be any signing of a ceasefire agreement, like there was none after the 12-Day War. I will reveal my broader thinking tomorrow after we see what happens in Islamabad (if anything).

While we wait, I would like to report what I discovered when I was writing the Weekly Forecasts dealing with the private credit sector. What I found was a massive surge in the amount of loans into non-depository financial institutions (NDFI) in the U.S. and abroad hidden in “hidden” loan categories.1 They indicate an explosion of systemic risk within the financial system.2

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Metropolitan Capital Bank & Trust was the 27th bank on the list of the worst 200 banks in the U.S. we published in mid-November (based on Q2 data). At the end of the month, we will update the list with Q4 data in our Banking Safety Service. In this entry (while we wait to see whether all hell breaks loose in the Middle East), I will detail why our Composite Risk Score, or CRiSe, warned of the risk of failure of Metropolitan Capital Bank & Trust months prior to its failure.1

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Over the weekend, I published the latest version of the intro to my upcoming book on Forecasting Financial Crises. It is freely downloadable from my SSRN page (requires a sign-up). I’ve been actively revising the book during the past few months. I promised to send a full manuscript to the editor of a publishing company sometime early next year (I am thinking by March). It would be the first step of bringing the project, which started in 2017, to an end. The book essentially combines my 25 years of thinking about money with my 17 years of research on economic growth and crises. It will be the magnum opus of both my economic academic and business careers, at least for now.

Today I thought to write few things about financial innovation and financial crises. As you learn from the intro, these two are inherently bound. Our economic prosperity owes everything to financial innovation, but it has come with a risk. Financial innovation tends to be followed by a boom and inevitable fall, like in 2008. We are now on the cusp of the latter.

An excerpt of the book summarizes the process of a bank run:

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We have received some queries about whether we would make these lists public. This is something we will not do, for two reasons:

1. We have been developing the analysis behind our risk metric for around two years, and it will be an integral part of our service offering in the future.

2. Most importantly, we do not want to have any part in creating or exacerbating a run on U.S. banks, which will most definitely recommence at some point. We consider this to be an important ethical responsibility. Our only aim is to shield our customers from the fallout of the next banking crisis. We ask also our customers to share this responsibility.

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The spring of 2025 has brought an unusual calm to American banking. Inflation is cooling, rate cuts have commenced, and deposit outflows have turned into major inflows. Yet, beneath the calm, the same structural pressures that triggered the regional banking crisis two and a half years ago still run through the system. Higher interest rates continue to suppress bond values, commercial real estate faces a mountain of delinquencies and refinancing cliffs, and smaller lenders compete fiercely for funding.

This is where we introduce our U.S. Bank Risk Score. Using the latest FDIC Call Report data,1 we’ve built a simple composite indicator that distills thousands of balance sheet figures into a single, comparable risk measure. It’s not meant to replace regulatory judgment or common sense but to quantify fragility and to show, using numbers, which banks may be standing on thinner ice than their peers.

The model takes inspiration from the FDIC’s classic CAMELS framework but focuses on what matters most right now: credit quality, liquidity, and exposure to rate shocks. It’s built entirely from publicly available data and is designed to assess a bank’s stability from a simple, yet effective approach.

In the special issue, in addition to introducing our metric, we publish the names and scores of 200 U.S. commercial banks found to be the least risky by it. Not a single bank scores 0 (the ultimate best), but some are close. We will publish the list of the worst (most risky) U.S. banks later this week.

Mate & Tuomas

Understanding the metric

The effectiveness of a risk model depends on the narrative its inputs convey. The five measures we have chosen reflect the main fault lines of this cycle: credit losses, property exposure, liquidity tightness, deposit stability, and market value risk.

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To begin with, CRE loans are occupying a large portion of the U.S. banking sector’s entire portfolio (Total Assets), standing at a significant 10%. CRE loans are also regarded as the most widely held loan type among banks, which is confirmed by the fact that the majority of banks (99%) have positive CRE loans. Basically, almost every bank in the U.S. is holding some type of CRE loan on their balance sheets. Therefore, it is no surprise that this is an area warranting close observation, especially because the risks posed by CRE exposure spread quite unevenly between large and small banks.

Figure 1 illustrates the average CRE concentration for banks based on their size, as a share of loans.

Community banks, which refer to small and medium sized banks, emerge as a primary source of concern due to their substantially higher exposure compared to their larger competitors. This is clearly visible in the figure, where, on average, these banks allocate 45% of their loans to CRE, while the largest banks maintain a more cautious concentration of around 12%. This difference is not unexpected, as community banks are inclined to take on more risks due to their lower capital requirements. This seemingly underscores the growing concerns surrounding community banks and their CRE portfolios, and this narrative is also heavily pushed by the media.

However, high CRE concentration alone do not inherently imply problems. The real issue arises from the combination of high concentrations, insufficient reserves, and delinquency issues. Therefore, it is essential to analyze the Coverage Ratio, which compares CRE to reserves for losses (Allowance for Loan Losses) plus Equity Capital.1 This ratio effectively measures the ‘leverage’ in the CRE portfolio. The higher the number, the higher the possible future risk.

Mid-sized banks are hovering at a Coverage Ratio of 300%, while the biggest banks maintain a modest 50%. This disparity seems to strengthen the argument that community banks are the primary issue. However, there is another side to the coin, when we examine Non-Performing Loans (NPLs) in CRE loans, they paint a different picture.

Non-Performing Loans are defined as loans that are either in non-accrual status or 90 days past due. The occurrence of NPLs is increasing across various bank portfolios, and the big banks are not excluded from this trend. The following figure presents the average CRE NPL percentage in CRE loans, categorized by the same bank sizes as previously analyzed.

The biggest banks are definitely the ones which are having NPL issues at the moment, which is even more visible when we look at the Non-farm Nonresidential Non-owner occupied component of CRE. This component is crucial, because a CRE loan is classified as a Non-farm Nonresidential Non-owner occupied if the borrower is making payments primarily from rental income, hence this category is very sensitive to any issue in the sector.

NPLs in the Non-owner component have reached worryingly high levels among big banks, while for the remaining sector, it stands at normal levels for now. As the largest component of commercial real estate loans, the significant spikes in NPLs among big banks will undoubtedly worsen credit conditions in the already troubled CRE market.

Conclusions

The issues with CRE loans have been circulating for some time, but the narrative often focuses on community banks. However, as we observed, identifying the weak links in the banking sector is not straightforward. Small and medium banks undeniably have a higher exposure to commercial real estate (CRE) compared to large banks, but they also have lower levels of non-performing loans.

Nevertheless, the situation is expected to soon reveal its impact. Banks facing increasing problems will raise their provisions, negatively affecting their profitability and, more importantly, the credit market. Bank failures are almost certain to follow, as warned by the Chairman of the Fed, Jerome Powell. Buckle up!

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Disclaimer:

The information contained herein is current as at the date of this entry.  The information presented here is considered reliable, but its accuracy is not guaranteed.  Changes may occur in the circumstances after the date of this entry and the information contained in this post may not hold true in the future.

No information contained in this entry should be construed as an investment advice nor advice on the safety of banks. GnS Economics nor any of the authors cannot be held responsible for errors or omissions in the data presented. Readers should always consult their own personal financial or investment before making any investment decision or decision on banks they hold their money in. Readers using this post do so solely at their own risk. 

Readers must make an independent assessment of the risks involved and of the legal, tax, business, financial or other consequences of their actions. GnS Economics nor any of the authors cannot be held i) responsible for any decision taken, act or omission; or ii) liable for damages caused by such measures.

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German property financer, Aareal Bank, has seen its bond price collapse due to its heavy exposure to U.S. CRE, while Deutsche Pfandbriefbank, who is also heavily invested in U.S. CRE, is experiencing heavy credit stress. This is a ‘canary’ of deeper issues, and losses, brewing in European banks.

In addition to issues going back to the 2008 crisis, European banks are struggling both with loan losses tied to the U.S. CRE and with those related to the collapse of the real estate sector in some European countries, like Germany. Moreover, the continent is facing a threat of an imminent recession. These imply that a crisis can engulf the European banking sector, practically, at any moment. Moreover, while the U.S. banks managed to improve their financial positions somewhat in Q4 (Tuomas will write about this later), their exposure to CRE is highly unevenly distributed.

This is why we issue a warning on the re-surfacing of the banking crisis. We also map the banks most vulnerable to the CRE collapse, based on Q4 data. Based on it, we issue an immediate withdrawal warning for four U.S. banks, while we flag 42 U.S. banks for withdrawal consideration.

The U.S. banks most exposed to CRE

We will publish two lists of banks, with 90 U.S. banks each. First, we list those banks who have the highest exposure to CRE. Second, we list the banks who would take the heaviest hit to their equity, if CRE loan losses would reach 10%, which can be considered something of a ‘consensus estimate’.

We will publish several loan loss scenarios based on Q4 data, including alternative loan loss scenarios on CRE, in the near future. We are also in the process of rooting out the banks who have been likely to tap into the Bank Term Funding Program (BTFP) of the Fed.

Here’s the first listing of banks with the highest exposure to CRE. This is an update and extension to the list we published in early February.

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In this warning we also list the U.S. banks with the highest exposure to collapsing commercial real estate (CRE) market. We issue a withdrawal warning on several U.S. banks.

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We will continue to analyze the Q3 banking data and will published further warnings and an updated list on the most-safe U.S. banks in the coming weeks.

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We will continue publishing the list of most vulnerable U.S. banks next week.

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Bank is an exceptional entity in the corporate world in many ways. Its product is a financial contract (debt) and it can create money out of ‘thin air’. There are a wide variety of misconceptions concerning banks and banking crises.

In this entry, I will detail why banks are inherently fragile due to their very nature and what characteristics you want a bank to have so that it can be considered safe. This entry also acts as an introduction to bank safety metrics we have constructed and will continue to develop. We have just published a list of the most-safe U.S. banks.

What is a bank?

This excerpt from a book I am writing on forecasting financial crises, comparing a bank to a tractor company, should make the difference between a bank and a normal corporation very clear.

Bank is an exceptional entity in the sense that while, for example, the output of a tractor company is tractors, the output of bank is debt. This makes the bank something of an anomaly in the corporate world. It follows the same accounting principles than any other corporation, but its output is a financial contract (debt). Commonly, this debt is given out as an IOU meaning that the bank gives a promise that whatever sum you deposit there, you get it back whenever you want making (a contractual warranty of short).1 In addition to deposits, this bank debt can be in the form of bonds, derivatives or inter-bank funding the bank has obtained from inter-bank markets. These are all liabilities to a bank, over which the holders have a claim.

This means that, because the output of a bank are debt contracts (deposits, bonds, etc.), their holders, i.e., customers can either claim or sell them at will. With the tractor company, customers naturally hold no such power over the production of tractors. The company will produce the tractor with its own timetable and customers cannot claim them to themselves before the tractor is finished (unless something else is agreed upon).

However, a bank can face a situation, where most of its customers can demand a very rapid repayment of the "production" (debt) they hold. That is, with a bank the claiming back of “production” can occur in multitude of ways as normal business transactions. This is why bank is such an exceptional entity and why the very structure, or the business model, of a bank makes it prone to a run.

The process of a bank run

Depositors can transfer their money digitally to other financial institutions or to assets or they can exchange their deposits into cash. If a large share of customers demand this at the same time, there will be a run on the deposits of a bank, where it faces a risk of running out of liquidity (assets to convert into money) causing the bank to fail. If the run on deposits is large enough, the bank will fail regardless, because its business model (taking deposits as a collateral for loans) fails. This is what happened, e.g., with the Silicon Valley Bank.

Holders of other forms of bank debt can sell their stocks and bonds en masse crashing their value. In the worst case, this leads to a collapse in the value of the equity of the bank pushing it into insolvency. Other banks can refuse to lend money to the bank in the inter-bank markets, and possibly demanding immediate payback of inter-bank loans, which will threaten the solvency of a bank, because it cannot obtain short-term loans to cover its acute liquidity needs (expect from a central bank). This all can also occur "overnight".

Depositors can issue claims to collect their deposits, while holders of stocks and bonds of a bank can issue selling orders at any hour. In practice, deposits will be transferred to another bank or turned into cash only, when the bank is open, while bonds and stocks will be sold only when markets are open. Still, the claim or the selling order can be made digitally at any hour for most of the bank debt.2

With any other form of company, with the possible exception of asset management companies, this cannot occur without some major violent external event. With the tractor company, for example, the only thing destroying its production in totality (in an "instant") would be an event, which destroys its factory, like an earth-quake or a fire. However, with a bank, such a destruction can occur in normal business transactions, which volume just becomes over-whelming. Essentially, the whole "production" of a bank can collapse in a very short period of time.

Banking safety

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The safest U.S. banks

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