Banking System Conditions
The banking system remains strong overall, with robust capital and liquidity and improved asset quality.
Overall, the banking system remains strong, although uncertainty is increasing because of the ongoing geopolitical tensions and the associated impacts. Capital and liquidity positions are robust, allowing banks to continue to support the economy and preparing them to withstand potential adverse market events. In the second half of 2021, asset quality metrics improved, bank profitability remained solid despite pressure on net interest margins (NIMs), and loan growth picked up.
Banks continue to report high levels of capital and liquidity.
The banking industry ended 2021 with strong capital positions. Since the pandemic began, the industry has added nearly $230 billion in additional common equity tier 1 (CET1) capital, providing support for lending and a buffer against losses. The aggregate CET1 capital ratio was 12.65 percent at year end, slightly above its five-year average (figure 1).
Figure 1. Aggregate common equity tier 1 (CET1) capital ratio
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Note: CET1 capital ratio is the ratio of common equity tier 1 capital to risk-weighted assets. See appendix A for further information. Community bank leverage ratio adopters (currently, about 37 percent of firms) are excluded.
Source: Call Report and FR Y-9C.
Banks also finished the year with ample liquidity. Liquid assets, such as cash and securities, now make up 28 percent of total assets at banks (figure 2). Strong deposit growth has spurred the increase in liquid assets and allowed banks to reduce their reliance on more volatile forms of funding.
Figure 2. Liquid assets as a share of total assets
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Note: Liquid assets are cash plus estimates of securities that qualify as high-quality liquid assets as defined by the liquidity coverage ratio requirement.
Source: FR Y-9C.
Banks reported lower delinquency rates in most loan categories.
Several asset quality indicators showed improvement in the second half of 2021. The aggregate loan delinquency rate fell below 1 percent and now stands at the lowest level since late 2006. The improvement was broad based, with banks reporting lower delinquency rates across most major loan categories (figure 3). The one exception was in consumer loans, where the delinquency rate remained low but increased slightly in the fourth quarter of 2021. An increase in late car loan payments drove the change.
Figure 3. Loan delinquency rates
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Note: Delinquent loans are those 90+ days past due or in nonaccrual status.
Source: Call Report and FR Y-9C.
At the same time, modified loan balances continued to decline as government pandemic programs come to an end. Loans modified in accordance with section 4013 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act fell for the sixth consecutive quarter to less than 25 percent of their peak (figure 4).1
Figure 4. Section 4013 loan balances
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Source: Call Report and FR Y-9C.
Large banks' internal risk ratings improved across most sectors. Ratings in commercial real estate (CRE) sectors most affected by the pandemic, such as hotel and retail properties, continue to lag other CRE sectors but have shown consistent improvement. Likewise, commercial and industrial (C&I) loan ratings in hard-hit sectors, such as the entertainment and recreation industry, improved throughout 2021.
After stabilizing in 2021, market indicators of bank health have weakened since the start of the year.
The strength of the banking system is reflected in market assessments of bank risk, including the market leverage ratio and credit default swap (CDS) spreads. The market leverage ratio is a market-based measure of a firm's capital position, where a higher ratio indicates more market confidence in the firm's financial strength. CDS spreads are a market-based measure of a firm's risk, where a lower spread indicates more market confidence in the firm's financial health. The aggregate market leverage ratio and average CDS spread for LISCC firms deteriorated sharply in the first quarter of 2020, but both indicators had recovered to their pre-pandemic levels by the end of 2021.
Because of increased uncertainty related to the Russian invasion of Ukraine, both market indicators deteriorated during the first quarter of 2022. In March 2022, the aggregate market leverage ratio declined to just under 9 percent, its lowest level since February 2021. The average CDS spread began rising in mid-January 2022 and has approached 100 basis points, its highest level since the Spring of 2020 (figure 5). Market indicators for European banks have largely followed the same trend as those for U.S. firms, with slightly worse performance.
Figure 5. Average credit default swap (CDS) spread and market leverage ratio (daily)
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Note: The market leverage ratio is the ratio of a firm's market capitalization to the sum of market capitalization and the book value of liabilities. Averages are calculated from available observations for the eight LISCC firms (Bank of America Corporation; The Bank of New York Mellon Corporation; Citigroup Inc.; The Goldman Sachs Group; JPMorgan Chase & Co.; Morgan Stanley; State Street Corporation; and Wells Fargo & Company).
Source: Bloomberg.
U.S. banks' direct exposure to Russia and Ukraine is limited. To date, the impact on bank operations has been modest. However, because of geopolitical tensions, U.S. banks have heightened their cyber defenses. Some have begun to exit from the region. U.S. banks have also taken steps to ensure compliance with sanctions imposed on Russian banks, companies, and individuals. Secondary impacts stemming from the war, such as increasing commodity prices and volatility related to energy, metals, and agricultural products, have significantly affected some markets and bank customers. The Federal Reserve is closely monitoring the effects on bank performance and their customers.
Bank profitability declined in the last three quarters of 2021 but remains sound.
Bank profitability, as measured by return on average assets (ROAA) and return on equity (ROE), declined in the last three quarters of 2021 back to pre-pandemic levels (figure 6). The decline is due to reduced benefits from negative provision expense and lower trading income at large banks. Bank revenues remain comparable with their pre-pandemic levels.
Figure 6. Bank profitability
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Note: ROE is net income/average equity capital, and ROAA is net income/average assets. 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.
Source: Call Report and FR Y-9C.
The banking industry's NIM, which is a measure of a bank's yield on its interest-bearing assets after netting out interest expense, continued to fall in the fourth quarter of 2021, as lower yielding assets increased faster than loans. Many large banks are projecting NIM to expand in 2022 as interest rates earned on bank assets are expected to rise while funding costs remain low.
Loan growth accelerated in the second half of 2021 after a sluggish start.
While total loan balances were roughly flat in the first half of 2021, loan growth accelerated in the second half of 2021. Loan balances increased across all major loan categories, with the largest growth rates reported in the consumer and other loan categories (figure 7).2 The growth reported in the other loans category is primarily driven by growth in loans to nonbank financial institutions and is discussed in greater detail in box 1. In the first quarter of 2022, loan balances have continued to grow, but the pace of growth slowed relative to the fourth quarter of 2021 for most loan categories. The only exception was the consumer loan category.
Figure 7. Outstanding loans by type
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Note: Data are for all commercial banks.
Source: H.8, "Assets and Liabilities of Commercial Banks in the United States."
Consumer loan growth was strong in the fourth quarter of 2021. Credit card balances increased at their highest quarterly rate since the first quarter of 2003, and other consumer loans increased at a brisk pace. Residential real estate (RRE) loan balances grew in the second half of 2021, posting quarter-over-quarter growth in both the third and fourth quarters. The third quarter increase marked the first quarterly growth for RRE balances since the first quarter of 2020.
Business loans also grew in the second half of 2021, as CRE and C&I loans increased. CRE loans showed the steadiest increase of the major loan categories. CRE loans are the only major category to increase in every quarter since the pandemic began. In contrast, C&I loan balances declined for five straight quarters, from the third quarter of 2020 through the third quarter of 2021. The decline reflected repayments from borrowers who drew down credit lines in the first half of 2020 and forgiveness of Paycheck Protection Program loans. The decline reversed in the fourth quarter of 2021, with C&I loans increasing more than 3 percent (figure 8). Respondents to the Federal Reserve's Senior Loan Officer Opinion Survey on Bank Lending Practices covering the fourth quarter of 2021 reported stronger C&I loan demand from businesses of all sizes.3 Banks also reported easing standards and terms for C&I loans, citing improved economic conditions and increased competition.
Figure 8. C&I loans and unused commitments
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Note: Assumes all PPP loans are C&I loans. Key identifies bars in order from top to bottom.
Source: Call Report and FR Y-9C.
Box 1. Trends in Loans to Nonbank Financial Institutions
Bank lending to nonbank financial institutions (NBFIs) has grown rapidly, growing 22 percent in 2021 (figure A). This contrasts with most other bank lending categories that slowed during the pandemic.
Figure A. Loans to nonbank financial institutions (annual growth)
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Note: Data are for all commercial banks.
Source: H.8, "Assets and Liabilities of Commercial Banks in the United States."
NBFIs engage in a wide range of activities, some of which are opaque and complex. Generally, NBFIs serve as intermediaries, borrowing from banks and investing in securities or lending to companies and households. While many NBFIs offer similar products as banks, they do not have full banking licenses and are subject to different regulatory requirements. NBFIs offer many different types of consumer lending, such as mortgages, auto loans, and credit cards.
One area of significant growth is bank loans to NBFIs focused on mortgage lending. These U.S. nonbank mortgage lenders issued 71 percent of all mortgages originated in 2021.1 NBFIs also provide loans to companies and investment funds. For example, aviation finance and equipment lending are also supported by loans from NBFIs.
Rapid growth in loans made by NBFIs could increase risk to banks, given the host of potential risks that NBFI activities present. The Federal Reserve will continue to monitor these loans, working with other regulators as appropriate, given relatively limited transparency into the wide range of activities in which NBFIs engage.
1. Source: Mortgage Lender Trends (Top 100 Lenders), Inside Mortgage Finance origination surveys and the Bank and Thrift Call Reports. Return to text
References
1. See appendix A for the definition of loan modifications under section 4013 of the CARES Act. Return to text
2. In the H.8, "Assets and Liabilities of Commercial Banks in the United States," this category includes loans to nondepository financial institutions and loans not categorized elsewhere. Return to text
3. See the January 2022 "Senior Loan Officer Opinion Survey on Bank Lending Practices" at https://www.federalreserve.gov/data/sloos/sloos-202201.htm. Return to text