While the recent and sudden deterioration of several U.S. banks has been most impactful to the depositors, shareholders and lenders to these institutions, non-bank financial institutions, insurance companies and funds have experienced a variety of knock-on effects that, although not yet material from a rating perspective, serve to underscore the risk of financial system interconnectedness, says Fitch Ratings.

Fitch also notes a number of broader second-order effects on the financial system as a whole related to asset price volatility, increased market scrutiny of unrealized losses and general market-risk aversion, that could ultimately adversely impact the financial profiles and ratings of non-bank financial institutions, insurance companies and/or funds if sustained and material.

These effects have primarily been observed in North American and, to a lesser extent, European markets. Asian and Latin American markets appear largely unaffected to date, primarily due to the geographic footprints of the now-failed banks not extending to these regions.

With respect to direct balance sheet, investment portfolio or counterparty exposures to now-failed banks, recoveries are expected to be low, although given the modest degree of exposure, the impacts to earnings and capital are expected to be immaterial. Fitch-rated insurance companies, for example, have an estimated $1.16 billion of debt and equity exposure to now-failed banks, primarily concentrated amongst life insurers, although this is mitigated by strong regulatory capital levels (no Fitch-rated insurer’s exposure is more than 1.5% of capital) and stable liability profiles.

For Fitch-rated funds, exposure to now-failed banks appears to be confined to a limited number of bond funds, closed-end funds and local government investment pools. Exposure amounts are limited, with no rating impacts expected. Positively, Fitch-rated money market funds do not have direct exposure to the now-failed banks, reflecting the funds’ focus on issuers rated ‘F1’ or higher.

Money market funds could be a particular area of rating sensitivity and systemic risk if investor risk aversion leads to elevated money market fund redemptions or if deposit outflows extend to more highly rated banks, which are the predominant component of money market fund portfolios. Conversely, money market funds could see inflows on the back of deposits being withdrawn from affected banks.

With respect to revolving credit facilities or other sources of financing previously provided by now-failed banks, this could modestly constrain certain affected financial institutions’ capacity for growth, liquidity or other financing initiatives, unless and until replacement funding providers are in place. That said, no Fitch-rated financial institutions had a material reliance on now-failed banks for funding capacity, particularly given the use of syndicated facilities, limiting the potential impact.

With respect to banking services or financing provided to underlying obligors of financial institutions, this is most relevant for lending conducted by business development companies and other commercial lenders, and in particular, underlying companies in the technology and healthcare sectors. That said, Fitch believes that the number of underlying obligors with affected banking relationships is immaterial, while regulators’ recent steps to grant systemic risk exceptions to Silicon Valley Bank and Signature Bank will ensure uninsured depositors at those institutions will be made whole.

With respect to financing provided to funds, this appears to be most acute in the subscription finance space, where alternative investment funds obtain short-term liquidity facilities from banks to bridge the timing of capital calls on fund limited partners (LPs). Where now-failed banks previously served as subscription finance providers, Fitch expects affected funds/managers to seek alternative financing providers, although at a minimum, this could slow the pace of future fund investments or require general partners to more frequently call capital directly from LPs.