Banking 'cancer' may be spreading as otherwise healthy firms seem vulnerable and credit gets pulled from the economy, Mohamed El-Erian says

• Banking sector "cancer" is starting to spread, Mohamed El-Erian said.
• Other regional lenders have shown signs of weakness after First Republic Bank failed this week.
• Widespread contagion would turn the banking situation into a true crisis, El-Erian warned.

Weakness within the banking system is starting to spread, as otherwise healthy firms are now vulnerable to the fallout stemming from multiple failed banks, and as credit availability contracts throughout the economy, according to famed economist Mohamed El-Erian.

In an interview with Bloomberg on Thursday, El-Erian pointed to the recent bout of banking volatility, with First Republic Bank reigniting fears after it collapsed and was bought by JPMorgan on Monday. That marks the third bank failure in two months – a consequence of the Fed's aggressive tightening cycle, poor financial supervision, and bad management, El-Erian said.

"Now we have stage 2, where banks that are not particularly badly managed  – they have issues but they're not particularly badly managed – are suddenly vulnerable," El-Erian warned, pointing to regional lenders that have been struggling since First Republic's failure this week. "The cancer within them is starting to spread, and we've got to keep an eye on that," he added.

Credit conditions are also beginning to tighten, and the risks of further contraction go up as banking contagion spreads.

If banking issues spur widespread financial contagion, the US would be in a true banking crisis, El-Erian said.That makes critical for regulators to contain the stress, he noted, adding that the US could also take steps to reform its federal deposit insurance.