Earlier this year, I warned of potential contagion or spillover effects from concentrated losses in the oil-exploration sector. In particular, there had been a jump in bad loans (30-days overdue) made by banks to US corporates.
I worried this could be self-reinforcing. Like a hedgehog, banks can be cute and cuddly when times are good. But when threatened, they curl up into a ball and don’t let anyone near them.
So when previously made loans turn sour, banks typically refuse to make new loans. Concentrated losses in one sector can therefore trigger a broader vicious circle. If banks are unable or unwilling to lend, businesses can’t expand and consumers can’t spend. This hurts economic growth which in turn makes it harder for existing borrowers to service their debts.
I wasn’t sure if the bad debts were entirely driven by the oil sector or reflected a broader squeeze on profit margins from the strong dollar, weak emerging markets and low unemployment. Recent micro-analysis by the New York Fed argues the losses were indeed limited to oil states. So with bad loans moving sideways, the worst is probably behind us.
What does this mean? It suggests the concentrated losses in the oil sector haven’t triggered a broader credit crunch. So banks should keep lending, the economy growing and unemployment grinding lower, while Fed rate hikes remain on the agenda.