Policy solutions to the banking crisis - a breakdown

Fears of a banking crisis have receded since last week, as KRE is off the lows and some of the worst hit names have rallied sharply. Regional banking names like PACW and WAL are exhibiting similar volatility to crypto shitcoins, and are up over 100% off their Thursday lows. The dramatic recoveries happened as suddenly and mysteriously as they started last week, without any clear catalyst. Some blame last week’s selloffs on a coordinated short selling campaign, and the subsequent recovery might be attributed to fears of a policy response over the weekend.

Last week’s bout of volatility in the banking sector wasn’t the first, and it won’t be the last either. The held-to-maturity portfolios of banks are still underwater, deposits are still flowing out of regional banks and into GSIBs and money market funds, and the credit portfolios of the banks are deteriorating along with the state of the economy. If crisis conditions erupt again, policymakers would come under pressure to act, just like the Fed did in establishing the BTFP facility in March.

Below is a non-exhaustive list of potential measures policymakers could take to staunch the bleeding, if more banks start to fail:

A ban on shorting bank stocks

This policy action was rolled out during the GFC, and is low-hanging fruit as it can be enacted by the SEC without any legal or Congressional roadblocks. Short interest on KRE is currently 66% of float while PACW is 18% of float. A ban on shorts would have immediate market impact and buy the market some time. However, the GFC showed that a short ban is ineffective over a longer time horizon, as bears can easily game the short-selling ban by reestablishing their exposure via puts. Existing longs can still lose confidence in banks and sell their holdings.