Banking System Conditions
Loan growth remains healthy.
Total loans outstanding within the banking industry continue to increase. Commercial and industrial (C&I) and commercial real estate (CRE) loans have demonstrated particularly strong growth, both rising over the past five years (figure 1). Of these two forms of lending, the C&I category has shown the greatest strength over the past year.
Figure 1. Loan growth by sector
Source: Call Report and FR Y-9C.
Concentration of bank lending continues to evolve. The share of loans at the largest and most complex banks—those overseen by the Large Institution Supervision Coordinating Committee (LISCC) (see table 1)—has declined gradually. As of the second quarter of 2019, domestic LISCC firms held around 40 percent of the banking industry's loans outstanding (figure 2), down from 46 percent in the first quarter of 2014. The decline in lending market share of LISCC firms largely reflects an expanding market position of regional banking organizations (RBOs).
Figure 2. Concentration of banking industry outstanding loans and leases
Note: Loan concentration is total loans in a given portfolio as a share of total loans in all portfolio groups.
Source: Call Report and FR Y-9C.
CRE loans are now the largest category of lending by U.S. banking organizations (figure 3). The share of loans backed by residential real estate has declined steadily in recent years, as nonbank lenders increase their market share. Residential real estate loans had historically made up the largest share of total loan holdings before the first quarter of 2019.
Figure 3. Loan composition
Note: Loan composition is individual loan categories as a share of total loans. Chart key shows bars in order from bottom to top.
Source: Call Report and FR Y-9C.
Loan performance is stable overall, but with some areas of concern.
The Federal Reserve continues to monitor the quality of loans held on bank balance sheets. Currently, nonperforming loans as a share of total loans and leases are low, at about 1 percent, and nonperforming loan ratios are improving or mostly stable for the banking system as a whole (figure 4).
Figure 4. Nonperforming loan ratio
Note: Nonperforming loan ratio is the ratio of loans 90 days or more delinquent and nonaccrual loans to total loans.
Source: Call Report and FR Y-9C.
The reserve coverage ratio—or the ratio of allowance for loan and lease losses (or ALLL, which is the amount of reserves banks set aside to absorb losses related to troubled loans) to the volume of nonperforming loans and leases held by a bank—has risen steadily since the first quarter of 2014, as nonperforming loans have declined (figure 5). A higher ratio generally indicates a better ability to absorb future loan losses.
While the overall trend in credit quality appears favorable, some areas of concern bear closer monitoring. The nonperforming ratio for consumer loans has trended upward slightly since mid-2015, rising about 20 basis points overall, although it remains low by historical standards.
Figure 5. Reserve coverage ratio
Note: Reserve coverage ratio is the ratio of ALLL to loans 90 days or more delinquent and nonaccrual loans. Data adjusted for Ginnie Mae guaranteed loans.
Source: Call Report and FR Y-9C.
Profitability is robust.
While bank profitability has plateaued in recent quarters, overall profits for the banking industry nevertheless stand at substantially improved levels relative to five years ago. Two important measures of profitability—return on equity (ROE) and return on average assets (ROAA)—have increased roughly 40 percent since the first quarter of 2014 (figure 6).1
Figure 6. Bank profitability
Note: ROAA is net income/quarterly average assets; ROE is net income/average equity capital. Values are annualized.
Source: Call Report and FR Y-9C.
Firms continue to maintain strong capital and liquidity.
Strong capital helps to ensure that banks can absorb unexpected losses and support the economy, including during an economic downturn. Aggregate capital levels for the domestic supervisory portfolios have remained strong since 2014, in some cases rising slightly over the past year (figure 10 and figure 17). Meanwhile, the share of institutions not well-capitalized has declined over the past five years and, as of the second quarter of 2019, amounted to only about one-half percent (figure 7).
Figure 7. Share of institutions not well-capitalized
Source: Call Report and FR Y-9C.
Besides capital, another critical ingredient to a resilient banking system is liquidity. Firms are required to maintain adequate levels of highly liquid assets (cash and securities easily convertible to cash) to be able to meet their obligations, even during times of financial stress. While the banking industry's holdings of liquid assets (reserves plus securities that qualify as high-quality liquid assets) declined slightly over the past several years, as of the second quarter of 2019, they remain substantially higher than before the financial crisis (at the beginning of 2007, this ratio was less than 3 percent) (figure 8).
Figure 8. Liquid assets as a share of total assets
Note: Liquid assets are reserves plus estimates of securities that qualify as high-quality liquid assets as defined by the liquidity coverage ratio requirement. These data are for FR Y-9C filers only.
Source: Call Report and FR Y-9C.
Key market indicators reflect confidence.
Strong performance of the U.S. financial system is reflected in the current level of market-based indicators of bank health, such as the market leverage ratio and credit default swap (CDS) spreads. The market leverage ratio is a market-based measure of a bank's capital position, where a higher ratio generally indicates investor confidence in a bank's financial strength. CDS spreads are a measure of market perceptions of bank risk, and a small spread reflects investor confidence in a bank's financial health. Both measures currently indicate market confidence in the banking system. CDS spreads of LISCC firms have fallen through the first half of 2019. Market leverage ratios, which had declined in 2018, have stabilized during 2019 (figure 9).
Figure 9. Average credit default swap (CDS) spread and market leverage ratio
Note: The market leverage ratio is the ratio of market value of equity to market value of equity plus total liabilities. Averages are calculated from available observations for the eight U.S. and four FBO LISCC firms only (U.S.: Bank of America, Bank of New York Mellon, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street, and Wells Fargo; FBO: Barclays, Credit Suisse, Deutsche Bank, and UBS). Beginning with this report, a different underlying data source was used for this chart. This has created minor time series differences, and the data could vary slightly from previous reports.
Source: Bloomberg.
Table 1. Summary of organizations supervised by the Federal Reserve (as of 2019:Q2)
| Portfolio | Definition | Number of institutions | Total assets ($ trillions) |
|---|---|---|---|
| Large Institution Supervision Coordinating Committee (LISCC) | Eight U.S. global systematically important banks (G-SIBs) and four foreign banking organizations (FBOs) with large and complex U.S. operations | 12 | 12.4 |
| State member banks (SMBs) | SMBs within LISCC organizations | 5 | 0.8 |
| Large and foreign banking organizations (LFBOs) | Non-LISCC U.S. firms with total assets $100 billion and greater and non-LISCC FBOs | 177 | 7.4 |
| Large banking organizations (LBOs) | Non-LISCC U.S. firms with total assets $100 billion and greater | 17 | 3.5 |
| Large FBOs | Non-LISCC FBOs with combined U.S. assets $100 billion and greater | 13 | 2.7 |
| Small FBOs | Non-LISCC FBOs with combined assets less than $100 billion | 147 | 1.2 |
| State member banks | SMBs within LFBO organizations | 8 | 1.0 |
| Regional banking organizations (RBOs) | Total assets between $10 billion and $100 billion | 88 | 2.1 |
| State member banks | SMBs within RBO organizations | 49 | 0.7 |
| Community banking organizations (CBOs) | Total assets less than $10 billion | 3,900* | 2.5 |
| State member banks | SMBs within CBO organizations | 719 | 0.5 |
| Insurance and commercial savings and loan holding companies (SLHCs) | SLHCs primarily engaged in insurance or commercial activities | 7 insurance 4 commercial | 1.0 |
Source: Call Report, FFIEC 002, FR 2320, FR Y-7Q, FR Y-9C, FR Y-9SP, and S&P Global Market Intelligence.
* Includes 3,835 holding companies and 65 state member banks that do not have holding companies.
Box 1. LIBOR Transition
An area of change that the Federal Reserve is monitoring involves risks associated with the transition away from the use of London Interbank Offered Rate (LIBOR).
LIBOR is currently used throughout the banking system as a reference to determine the interest rate on a variety of financial products, such as derivatives and loans to businesses and consumers. In July 2017, the U.K. Financial Conduct Authority, which has regulated LIBOR since 2013, announced that it intended to preserve LIBOR's continued publication by reaching a voluntary agreement with the remaining panel banks to continue submissions through the end of 2021, but it will neither seek to persuade nor compel panel banks to participate in LIBOR panels after year-end 2021. This announcement indicates that LIBOR could cease to exist after 2021, which would have ramifications for its use as the benchmark reference rate for an estimated $200 trillion in U.S. dollar exposures and $370 trillion globally.
The anticipated end to LIBOR will necessitate the transition to alternative reference rates, while seeking to minimize any potential harm to consumers and manage any associated legal or reputational risks. The transition away from LIBOR will be a complex and challenging undertaking and will require significant attention and priority over the next several years to avoid disruption and manage associated safety and soundness risks. For example, risk management, monitoring systems, and models that depend on LIBOR as an input will likely need to be updated. Financial contracts linked to LIBOR may need to be updated to be sufficiently robust to withstand a transition away from the use of LIBOR.
The size of such transition tasks points to the importance of current planning and risk-mitigation efforts. Senior management at financial institutions are in the best position to assess and manage the range of firm-specific risks that may arise over the course of the transition.
References
1. The dip in ROE and ROAA in the fourth quarter of 2017 was driven by a one-time tax effect associated with the Tax Cuts and Jobs Act of 2017. Return to text