The stock market has been nervous about the condition of the financial sector for a while now, and concerns mounted once again on Tuesday. Major market indexes were down between 1% and 2% at midday as investors wondered if the latest bank failure would prove to be the last. Moreover, against the backdrop of the ongoing Federal Reserve meeting to decide what to do with interest rates, market participants seemed particularly on edge.

Among regional banks, significant declines were prevalent. PacWest Bancorp (PACW) and Western Alliance Bancorporation (WAL 5.54%) were among the worst performers in the industry on Tuesday, and the drops in bank stock prices certainly suggest that the investing community needs more reassurance about how the banking system will handle current pressures.

PacWest leads banks lower

Shares of PacWest Bancorp were down 27% as of 12:30 p.m. ET. The Beverly Hills-based banking institution has seen its stock fall by more than 75% since early March as investors fear that some of the same problems that led to past bank failures elsewhere could threaten PacWest as well.

To be sure, PacWest had a tough first quarter of 2023, with a $1.38 billion goodwill impairment causing the bank to post a massive loss for the quarter. Moreover, PacWest said that it saw pressure on its deposit base during the quarter, most notably in its venture banking business line. Deposits fell from $33.9 billion at the end of 2022 to $28.2 billion as of March 31.

However, in its quarterly report in late April, PacWest said a lot to reassure investors about what was happening. Deposit balances had actually gone up by $700 million from the end of the first quarter to April 24. Moreover, the company worked to boost its liquidity, making sure that its access to cash would be more than sufficient to cover uninsured deposits even if those customers chose to take their money out of their PacWest accounts.

PacWest faces plenty of economic challenges, including the Fed's quantitative tightening, a sluggish economy, stubbornly high inflation, and prospects for a weaker environment for its venture banking business. Combined with the lack of resolve among larger banks to look at consolidation rather than letting smaller regional financial institutions fail, it's understandable why shareholders are concerned about PacWest right now.

Western Alliance sinks again

Shares of Western Alliance Bancorporation were also sharply lower, falling 21% at midday. The Phoenix-based bank held up somewhat better than PacWest, but its stock is still down 60% from its levels of just a couple of months ago.

Western Alliance's first quarter showed some similarities to PacWest's. Deposits dropped from $53.6 billion at the end of 2022 to $47.6 billion as of March 31, although the bank got a $2 billion rebound in deposits by its April 14 release of its financial results. Moreover, unlike many of its peers, 73% of its deposits as of April 14 were insured by the FDIC.

Still, Western Alliance made tough decisions to boost its balance sheet strength, reclassifying $6 billion in loans and taking a $123 million pre-tax charge due to their loss in value. Western Alliance also is contemplating further asset sales in the second quarter in order to generate more cash and get its key capital adequacy ratio back above the 10% mark.

The problem banks face is that their costs of maintaining deposits are rising after a long period of essentially not having to pay much, if any, interest to depositors at all. That's a tough shift, but it was unreasonable for investors to think that banks could reap the benefits of higher interest income on loans without paying at least some of that back to their deposit customers.