- Key insight: Banks' direct exposures and losses from the Iran conflict have been limited, but the longer the war goes on, the greater the risk of recession and broader financial losses become, experts say.
- Supporting data: Consumer sentiment fell to the lowest level ever in April, according to the University of Michigan's latest report. At the same time, financial experts say unemployment is low and household spending continues to be robust.
- Forward look: Economists say the longer the conflict carries on — and the longer traffic through the Strait of Hormuz is disrupted — the greater the risk of stagflation becomes.
As the U.S. war with Iran enters its second month, experts are worrying that a prolonged disruption at the Strait of Hormuz could send negative ripples across the broader economy — including second-order effects on bank balance sheets.
The central geopolitical variable is not Iran itself, but whether disruption to global energy flows becomes prolonged and unpredictable, said Nicolas Véron, senior fellow at the Peterson Institute for International Economics. How much pain banks ultimately feel because of the conflict ultimately hinges on when and whether energy is able to flow out of the Persian Gulf freely, as it did just a few months ago, he said.
"It's hard to avoid that question [of the strait]," Véron said. "In a scenario where it reopens with no risk of being blocked by any of the parties, it would be manageable for the global financial system. Of course you would have companies that have been disrupted, but overall it would be a relatively benign situation."
The best-case scenario at this point hinges on the outcome of ongoing negotiations with Tehran. On Tuesday, the White House announced it was suspending Vice President J.D. Vance's planned trip to Pakistan for a second round of talks with Iranian officials after Iran didn't respond to a negotiating position the U.S. offered. Later in the day, President Trump said he was
A prolonged disruption in the strait of Hormuz will continue to drive uncertainty that markets and banks struggle to price, particularly given broader regional exposure. Market participants can't be sure the damage is reversible either, according to Véron.
"I think the problems are with a prolonged closure of the straight and associated with that, the uncertainty about when things might return to normal, if ever at all," Véron said. "The strait remains the key parameter."
While direct exposure to Iran is limited, Véron said, risks tied to the Gulf region are more consequential and uneven across different firms.
"Global banks have de-risked from Iran many years ago, so there is no direct exposure to the Iranian economy in the international financial system," Véron said. "Where there is much more exposure is, of course, to the Gulf countries. If there was a situation that would put into question the very viability of economies in that region, obviously that would have ripple effects that are not priced in at this point."
So far so good
For now, those risks remain largely theoretical, according to analysts.
"We've had a pretty good season of earnings results so far. All the major banks commented on the resiliency of the consumer," Biggar said. "They're still spending, borrowing, and investing, and that's good."
Even so, that resilience is uneven, with resilient spending by high income households, which make up the majority of spending, driving growth. Those numbers offset the negative affects of economic insecurity felt by lower-income consumers, who face more immediate pressure from rising costs.
"There's clearly a continuing dichotomy between affluent and less affluent [consumers, where] If you need to pay more for fuel, you've got less for discretionary items," Biggar said. "But the affluent — where most of the spending growth has come from — are kind of unaffected, similar to how they were through the big inflation period. The affluent kind of spent through it."
That mismatch, between wall street and main street, also shows up in how consumers say they feel about the economy. Consumer sentiment fell sharply in April, with the Index of Consumer Sentiment dropping about 11% to 47.6, its weakest reading in history according to the University of Michigan consumer sentiment
Biggar says this disconnect was a frequent topic of conversation on earnings calls.
"Banks said, 'look, we see this consumer sentiment is at the lowest point in 10 years,' but you know what consumers say on surveys and what they do in terms of spending, banks are seeing [a disconnect]," Biggar said. "Consumers might say they don't feel good about their job, the environment, [or that] inflation is too high … and that brings down the results, but yet they continue to spend more, they borrow more, they invest more."
Despite the disconnect, Biggar said credit quality has held up as well, supported in large part by a relatively stable labor market. U.S. job growth
"One of the biggest influences on credit quality for banks is the unemployment rate … if you get a big spike in unemployment, you'll get a spike in delinquencies and charge-offs," Biggar said. "In the most recent number, it actually ticked down … so jobs are still available, plentiful."
Still, an oil-driven shock would work through the economy gradually, eroding household savings and discretionary spending — and, eventually, reducing the flow of those savings to banks, which turn them into loans, according to macroeconomist Jai Kedia, a research fellow at the Cato Institute.
"If we're going to have these massive surges in inflation as a result of oil price spikes … people are going to adjust their investing behavior as well," Kedia said. "If they have to set aside more money towards consumption, that means less money for savings. That means less money entering the financial sector."
The specter of stagflation
Because oil is a key input across the economy — and the Strait of Hormuz is a key input in the price of oil — the Iran war has the potential to drive up prices for a wide array of consumer goods and services well beyond energy and transportation.
"Oil is an essential commodity across the economy, so when oil prices increase, it's not just oil that's increasing," Kedia said. "Basically all the prices in the economy are going to go up."
Jai warns that this kind of supply shock creates the potential for stagflation, where economic stagnation and inflation are present in the economy at the same time. Such a scenario leaves policymakers — namely the Federal Reserve — with limited tools to manage consumers' pain: raising interest rates may control inflation, but at the cost of employment, and lowering them has the opposite effect.
"The Fed wants to increase rates to lower inflation, but decrease rates to bring employment back up, so you're kind of stuck between a rock and a hard place when it comes to being a monetary policy agent," Kedia said. "So if this is indeed a large supply shock, people shouldn't expect the Fed to be able to alleviate all of that."
"It's very similar to what happened in the Middle East in the 1970s, when you had rampant inflation and unemployment," Kedia continued. "It's hard for the monetary policy agent to deal with that."
Bank regulators and Congress have little direct role at this stage, said Ian Katz, Managing Director at Capital Alpha Partners.
"I don't see much of a role for other regulators or Congress in the short- to medium-term," Katz said. "I think supervisory posture would be the first to change … supervision can change informally, without the need for a formal rulemaking process. Examiners could reiterate the importance of risk management. I think liquidity and cross-border exposures are things that supervisors would be telling banks to be wary of if the economy worsens," Katz said.
Ultimately, Kedia says the biggest risk may be the uncertainty itself — particularly if the conflict drags on and markets don't have a reason to feel more optimistic.
"The one thing I can say with certainty, though, is it's extremely uncertain," Kedia said. "That's not good for anyone."
