A tariff-driven recession could strain the U.S. banking sector by eroding credit quality and slowing investment, increasing the likelihood of small and mid-size bank failures, experts say. That could drive an uptick in government-assisted M&A deals, continuing the trend of consolidation in the industry.
Todd Baker, a senior fellow at the Richman Center at Columbia University and managing principal of Broadmoor Consulting, said he is concerned because such strain on the banking system comes at a time when the chief bank rescuer — the Federal Deposit Insurance Corp. — has endured staff reductions.
"I would normally say that past history demonstrates that the FDIC is prepared to staff up for and manage recessions and credit problems, but the mass firings/forced retirements at the agency likely under [the Department of Government Efficiency, or DOGE] are very concerning," Baker said. "If banks do begin to fail in any quantity, the agency will be hard-pressed to put experienced receivers in place, and may be constrained in hiring temporary employees to deal with a crisis of any magnitude."
President Donald Trump's sudden tariff rollout — and
Mortgage and crypto markets briefly rallied after Trump paused most tariffs, but the
"While no one really knows where the tariff situation will settle, it is likely to lead to a recession in the U.S. unless the administration pulls back substantially," Baker said. "Small, mid-sized and large companies dependent on imported inputs from China and importers in general will be hurt badly by high tariffs, as will businesses in areas dependent or foreign travel such as hotels, airlines and payments companies like Visa and Mastercard. Any offsetting benefit for domestic companies will take a long time to materialize, and new investment is likely to be constrained unless the administration's policy stabilizes enough to allow reasonable business planning."
Joseph Lynyak, a partner at Dorsey & Whitney, said uncertainty will continue as the tariffs work their way through the system.
"In the Midwest's agricultural sector, [it could be that] a family farm is going to be under increased pressure because the crops they're growing are going to affect financing on the part of banks," he said. "And you can move that all the way up the food chain to global financing and midsized banks as well, so I think the banking sector is keeping a close eye on it, and it's going to have to see how the repercussions affect their chosen industries."
Baker also noted that consumer credit stands to suffer badly in any recession, which is unfortunate for larger and specialized banks with a consumer focus.
"There could be some offset from interest rate moves by the Fed, but not enough to prevent consumer loan losses from rising substantially," Baker said. "We will not really understand which banks have the most exposure for some time, as the impact on lenders will only become clear over time as different borrower segments adjust to the new tariff regime."
One possible upside, he said, is that the current system banks use to prepare for loan losses — the Current Expected Credit Losses standard, known as CECL— is more cautious than the old method used during the last recession. That means banks may not need to set aside as much money right away if the economy starts to slip, since they've already built in some protection.
But still, the coming wave of instability in the industry arrives as a bad time for the FDIC. Staffing cuts being overseen by Trump and
Lynyak said he is not overly worried about the effect of staff cuts, given the FDIC's track record and expertise.
"There's a very strong, well-understood policy in place to handle any deterioration in asset quality that a bank may experience, whether or not there's slightly less examinations or the use of technology to do more work site review. That's an evolving process, but I don't see that as being altered significantly," Lynyak said. "The examination function for banks is done on a regional basis — not at the headquarters office — so you're still going to have staff doing their normal examinations."
At the same time, an unresolved toxic
"As a result of staff attrition," the OIG
Upon the resignation of former FDIC Chair Martin Gruenberg, FDIC Vice Chair Travis Hill assumed the duties of acting chair. Hill, a Republican member of the board who was appointed by former President Joe Biden before his ascent to the top of the agency under Trump, has expressed his preference for selling off banks to other financial institutions rather than setting up bridge banks due to speed and clarity that bolster consumer confidence.
Baker said in the event of an emergency failure, large banks like JPMorgan Chase — who
"Given the Trump administration's lack of apparent concern about bank consolidation, I would think that M&A assisted transactions are the most likely type of resolution, as they are quicker and easier, if sometimes more expensive, than other alternatives," Baker said. "I expect that private equity buyers will be preferred buyers in many cases, which will require some relaxation of control rules."
Under law, companies that obtain 10% or more of a stake in a bank can be considered to have a controlling interest in the bank, and thus be subjected to heightened regulatory constraints, particularly concerning extensions of credit from the bank to the nonbank owner and related affiliates. Many firms have historically avoided those restrictions under "
Art Wilmarth, a professor of law at George Washington Law School, said Hill's remarks clearly express a preference for mergers, but that these types of transactions almost always require significant financial assistance from the FDIC. JPMorgan and the FDIC entered into a cost-sharing agreement for the nation's largest bank's acquisition of First Republic. Wilmarth said this worsens the "too-big-to-fail" problem in the U.S.
"JPMorgan could not have acquired First Republic in a standard deal because JPMC already held more than 10% of nationwide deposits and was therefore prohibited from making further interstate acquisitions under Dodd-Frank's 10% nationwide deposit cap for healthy bank acquisitions," Wilmarth said. "The First Republic assisted acquisition was therefore an incredibly attractive deal for JPMC. One wonders whether the FDIC could have negotiated harder for a less costly deal to the Deposit Insurance Fund."
At the time of First Republic's sale, the FDIC stated that JPMorgan Chase's acquisition was less costly than liquidating the bank and paying off insured depositors, but it did not provide detailed analysis to support that conclusion. Under the FDIC's least cost resolution requirement, the agency must choose the option that minimizes losses to the Deposit Insurance Fund — typically based on a comparison of bids and projected costs — raising questions about transparency when such analyses aren't disclosed.
The longer it takes to sell a failed bank, the more damage it does to consumer confidence in the system and the FDIC. Wilmarth said arranging a weekend M&A deal requires far less staff time than running a bridge bank and gradually offloading deposits and assets.
"I'm not suggesting that staffing problems are an important factor behind Acting Chairman Hill's preference for weekend M&A resolutions," Wilmarth said. "But staffing issues might not be irrelevant to his preference."
Wilmarth said merger resolutions come with their own risks, citing Flagstar's
Lynyak said regulators' likely approach following the 2023 bank failures is likely to prioritize preserving the perception of stability in the banking industry.
"[Hill's] speech recognizes the fact that [swift resolution] is important to the way that the public perceives the strength of the banking system and that no one has ever lost any funds, and they will continue that," he said. "Because that is the last thing you want to do — put the threat of another Silicon Valley Bank on the table."
The FDIC did not respond to request for comment.
