Economic contractions have frequently been led by weakness in the household sector, which often has responded to higher interest rates as the Federal Reserve acts to reverse inflation pressures. This pattern can be seen in the chart, where the spending shares of housing and consumer durables typically drop sharply before and during recessions.
The loss of high-quality borrowers thus introduces not only systematic vulnerabilities but also portfolios that are less idiosyncratic and more sensitive to the business cycle. Idiosyncratic risks have always loomed larger in small bank portfolios because their borrowers' well-being reflects such a wide range of factors, especially local and regional developments.