Mohamed El-Erian says regional banks are in a ‘hospital’ phase of turmoil, but a Fed policy mistake will drive them ‘back into the ICU’

• The regional banking crisis has shifted out a severe stage, economist Mohamed El-Erian told Bloomberg on Tuesday.

• But another Fed policy mistake could drive small to mid-sized lenders “back into the ICU.”

• El-Erian has been a critic of the Fed reacting too slowly to raging inflation with rapid rate hikes.

The turmoil engulfing the regional banking sector this year has stepped out a severe stage but could reaccelerate if the Federal Reserve makes another policy misstep, economist Mohamed El-Erian said Tuesday.

“We are still in the hospital because there are problems with the banking model of certain banks,” El-Erian told Bloomberg Television about where the US currently stands with stress facing small and mid-sized lenders.

Their distress erupted in March when Silicon Valley Bank and Signature Bank became the first lenders to collapse and be seized by federal regulators since the global financial crisis.

“The key issue now is to allow the patients that are in the hospital to come out. If there’s another [Fed] policy mistake, the patient goes back into the ICU,” said the chief economic adviser at Allianz.

The Fed’s quick run of interest rate increases has been blamed for contributing to bank failures this year. SVB’s bond holdings sank in value after the Fed began jacking up its key interest rate from a floor of zero percent in March 2002. A fire sale of SVB’s bond portfolio resulted in huge losses, stoking the bank’s eventual demise.

Depositors have yanked hundreds of billions of dollars out of regional lenders collectively this year, including PacWest and First Republic Bank. The latter, which catered to wealthy clients, failed earlier this month, and JPMorgan bought the bulk of its assets.

But weekly deposit flows have been stabilizing, said Fitch Ratings.

El-Erian has been a vocal critic of the Fed for reacting too slowly to soaring inflation and then racing to cool inflation to its 2% target with fast rate hikes. The 10th consecutive increase was issued in May and economists widely expect the US is heading into a recession.

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What would another policy mistake look like to El-Erian?

“We ignore the fact that we can’t get the 2% inflation [target] easily and we go after it too quickly,” he said. That would also create a “second set of patients,” including non-banks in the financial sector such as businesses in the commercial real estate market.

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