Banking System Conditions
The banking system remains financially sound amid changing economic conditions.
Banks' financial condition generally remains sound. Loan growth and higher interest rates are beginning to modestly boost the net interest margin, a measure of the income banks earn on loans and investments after deducting their funding costs. Problem loans remain low, as banks report low delinquency measures across all major loan categories. The industry continues to report capital and liquidity above regulatory minimums.
However, banks face challenges. The values of investment securities have fallen. In addition, some borrowers' ability to repay floating rate loans may be adversely affected by resetting loan rates.
While recent stress test results showed that large banks would be well positioned to continue lending to households and businesses under simulated stressful conditions, firms will need to ensure that their stress analyses, liquidity, and capital positions adjust to developing market conditions, which may differ from the recent simulations.1
Loan balances continue to increase.
Loan balances grew in the first three quarters of 2022, with robust loan growth across all major loan categories (figure 1). The commercial and industrial (C&I) and consumer loan categories had annualized growth rates above 10 percent in each of the first three quarters of 2022. Growth in consumer loans was primarily driven by higher credit card balances. Residential real estate (RRE) loans steadily increased in the first three quarters of 2022.
Figure 1. Outstanding loans by type
Accessible Version | Return to text
Note: Data are for all commercial banks.
Source: H.8, "Assets and Liabilities of Commercial Banks in the United States."
Growth in the "other loans" category remained strong through the third quarter of 2022.2 As noted in the May 2022 Supervision and Regulation Report, loans to nonbank financial institutions are responsible for most of the growth in the "other loans" category over the past few years.
Commercial real estate (CRE) loans grew despite reports of tighter lending standards in the Federal Reserve's July 2022 "Senior Loan Officer Opinion Survey on Bank Lending Practices." Surveyed banks reported tighter standards and weaker demand for most CRE loan categories. The exception was in loans secured by multifamily properties, where banks reported stronger demand.3
In 2022, loans grew faster than deposits. As discussed in box 1, this is a reversal of the trend since the onset of the pandemic.
Bank financial performance remains stable.
Bank return on average assets and return on equity remained sound in 2022, declining a bit from their levels during the first half of 2021. Despite recent softening, both return on average assets and return on equity remain in line with historical levels (figure 2).
Figure 2. Bank return on average assets (ROAA) and return on equity (ROE)
Accessible Version | Return to text
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 recent decline in bank return on average assets and return on equity was largely driven by higher loan loss provisions, as banks added to their credit loss reserves for loans and leases amid accelerated loan growth and economic uncertainty.4 After reporting $5.3 billion in loan loss provisions in the first quarter of 2022, the industry reported another $11.7 billion in the second quarter. Still, loan loss provisions remain below their pre-pandemic level (figure 3).
Figure 3. Provisions for loan and lease losses as a share of average loans and leases
Accessible Version | Return to text
Source: Call Report and FR Y-9C.
After reaching a low point in 2021, the industry's net interest margin increased modestly in the first half of 2022. Net interest margin widened as yields earned on loans and other assets moved up faster than rates paid on deposits. Responses to the Federal Reserve's May 2022 "Senior Financial Officer Survey" suggested that banks had passed through only a small portion of the general increase in interest rates this year to deposit customers.5 The lag in raising rates paid on deposits may have contributed to the leveling off in deposit balances.
Box 2 provides a summary of bank financial performance and capital positions through the third quarter based on the earnings results for a set of large banks.
Banks continue to report low delinquency and net charge-off rates in major loan categories.
Problem loans remain low. The aggregate loan delinquency rate dropped to its lowest level since the end of 2005, as delinquency rates declined or remained flat across all major loan categories in the first half of 2022 (figure 4).
Figure 4. Loan delinquency rates
Accessible Version | Return to text
Note: Delinquent loans are those 90+ days past due or in nonaccrual status.
Source: Call Report and FR Y-9C.
Net charge-off rates stood near 15-year lows across all major loan categories. Only the consumer loan net charge-off rate increased in the first and second quarters of 2022, largely driven by credit card charge-offs (figure 5).
Figure 5. Loan net charge-off rates
Accessible Version | Return to text
Source: Call Report and FR Y-9C.
Large banks' internal loan risk ratings continued to improve, as most sectors saw similar-to-stronger ratings in the first two quarters of 2022. C&I loan ratings in sectors most affected by the pandemic, such as the entertainment and recreation industry, had the most significant ratings improvement. Meanwhile, ratings in most CRE sectors remained stable or improved.
Capital and liquidity positions remain adequate, while securities depreciation is significant at some banks.
Despite a modest decline in the first half of 2022, the banking industry's capital position remains adequate. The industry aggregate common equity tier one (CET1) capital ratio was 12.1 percent at the end of the second quarter, slightly below its five-year average (figure 6). The recent decline in the CET1 capital ratio reflects both a slight decline in the level of capital (the numerator of the ratio) and an increase in risk-weighted assets (the denominator of the ratio). The industry's CET1 capital decline was driven in part by unrealized losses on available-for-sale securities at the largest firms (box 3).6 The industry added over $653 billion of risk-weighted assets in the first half of 2022 amid robust loan growth.7
Figure 6. Aggregate common equity tier 1 (CET1) capital ratio
Accessible Version | Return to text
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 36 percent of firms) are excluded.
Source: Call Report and FR Y-9C.
Liquid assets, such as cash and securities, remain at historically high levels. Securities depreciation contributed to a reduction in liquid assets as a share of total assets in the first half of 2022 (figure 7).
Figure 7. Liquid assets as a share of total assets
Accessible Version | Return to text
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.
Box 1. Deposit Growth Slows while Loan Growth Accelerates
Banks saw extraordinary deposit growth between the end of 2019 and the start of 2022, as the onset of the pandemic triggered a surge in deposits. During this period, commercial banks added nearly $5 trillion in deposits. Banks invested much of the deposit inflow into liquid assets, such as cash and securities, rather than using the deposits to fund loans. While deposits are generally a stable source of funding, investing in liquid assets provided banks with protection against the potential for those deposits to be suddenly withdrawn. As deposits were growing rapidly, loans grew slowly in 2020 and 2021.
As a result, the ratio of loans to deposits fell from 76 percent at the end of 2019 to under 60 percent in the third quarter of 2021. The ratio of loans to deposits is a common measure of bank liquidity. A declining ratio typically signals increasing liquidity, as more deposits are available to fund a bank's loans. In contrast, the ratio of loans to deposits steadily rose in 2022, as loan growth has been strong while deposits have leveled off. As seen in figure A, the loans to deposits ratio has retraced more than one-third of the decline that was triggered by the onset of the pandemic; however, it remains low compared to historical levels, suggesting liquidity remains sound.
Figure A. Loans to deposits ratio
Accessible Version | Return to text
Note: Data are for all commercial banks.
Source: H.8, "Assets and Liabilities of Commercial Banks in the United States."
Bank market indicators have weakened since the start of 2022.
Market assessments of bank risk, including the market leverage ratio and credit default swap (CDS) spreads, provide supervisors with an independent, forward-looking assessment of the strength of the banking system. 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.
The average market leverage ratio and average CDS spread for firms supervised by the Large Institution Supervision Coordinating Committee (LISCC) program deteriorated in the first half of 2022 amid increased uncertainty related to the Russian invasion of Ukraine and as market participants reassessed the potential for an economic slowdown. Both indicators recovered slightly at the start of the third quarter. However, between mid-August and mid-October, the average market leverage ratio has fallen and the average CDS spread has increased (figure 8).
Figure 8. Average credit default swap (CDS) spread and market leverage ratio (daily)
Accessible Version | Return to text
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: Federal Reserve staff calculations using Bloomberg data.
Box 2. Year-to-Date Earnings at Large Firms
This box provides a preliminary recap of banking sector conditions through September 30, 2022, based on early reporting by a sample of large U.S. banks that reported third-quarter earnings on or before October 21.1 While such trends are indicative, it should be noted that the sample may not necessarily be representative of the banking sector.
Earnings Approximate Pre-pandemic Levels, though down Year-over-Year
Large banks' earnings were near pre-pandemic levels in the first nine months of 2022, but below levels earned in 2021. Aggregate bank profitability, as measured by return on equity, approximated 11 percent in the first nine months of 2022, compared with 12 percent in the first nine months of 2019 and 15 percent earned in the first nine months of 2021 (figure A).
Figure A. Aggregate annualized return on common equity
Accessible Version | Return to text
Note: Aggregate annualized return on common equity calculated as annualized quarterly net income available to common shareholders divided by average quarterly common shareholders' equity.
Source: Federal Reserve staff calculations using data from S&P Global Market Intelligence and Earnings Releases.
Relative to the first nine months of 2021, 2022 year-to-date growth in net interest income partially offset lower noninterest income, higher operating expenses, and the increase of loan loss reserves. Net interest income growth reflects the effect of rising interest rates on asset yields and accelerated loan growth. Declines in noninterest income were driven by lower investment banking and mortgage fees, while increased operating expenses largely reflect higher compensation expenses.
Credit loss provisions in the first nine months of 2022 increased relative to the first nine months of 2021, as banks built loan loss reserves amid loan growth and increased macroeconomic uncertainty. Loan loss reserves as a percent of loans have remained near 2021 year-end levels (figure B). Indicators of asset quality deterioration have remained near historically low levels.
Capital Ratios Declined Year-to-Date, and now Approximate the Pre-pandemic Level
Common equity tier 1 (CET1) capital ratios declined modestly since the start of 2022. The aggregate CET1 capital ratio for the sample approximated 11 percent on September 30, 2022, which was near the level immediately preceding the pandemic (figure C).
Figure B. Aggregate loan loss reserves as a percent of total loans
Accessible Version | Return to text
Note: Total loans reflects loans and leases held for investment. Total loans reflects loans and leases held for investment. Due to disclosure limitations on loan loss reserves in 2022:Q3, The Charles Schwab Corporation is excluded from the aggregate loan loss reserves as a percentage of total loans ratio in all periods. Due to disclosure limitations, 2022:Q3 loans and leases held for investment for American Express Company, The Goldman Sachs Group, Inc., JPMorgan Chase & Co., M&T Bank Corporation, Morgan Stanley, Northern Trust Corporation, and State Street Corporation illustratively extrapolated by applying 2022:Q3 quarter-over-quarter total loan growth rate to 2022:Q2 loans and leases held for investment balances.
Source: Federal Reserve staff calculations using data from S&P Global Market Intelligence and Earnings Releases.
Increased risk-weighted assets, reflecting robust loan growth and market volatility, contributed to approximately 60 percent of the year-to-date decline in the aggregate CET1 capital ratio. Unrealized losses on available-for-sale securities, driven by rising interest rates, also reduced CET1 capital ratios for Large Institution Supervision Coordinating Committee firms and certain large banking organizations. To help preserve CET1 capital amid macroeconomic uncertainty and increased regulatory requirements effective as of October 1, 2022, some banks either slowed or suspended share repurchases.
Figure C. Aggregate common equity tier 1 capital ratio
Accessible Version | Return to text
Note: “Due to disclosure limitations on CET1 capital and risk-weighted assets in 2022:Q3, The Charles Schwab Corporation, KeyCorp, M&T Bank Corporation, and Northern Trust Corporation are excluded from the aggregate CET1 ratio in all periods.
Source: Federal Reserve staff calculations using data from S&P Global Market Intelligence and Earnings Releases.
1. The sample includes the following 20 large U.S. bank holding companies and one savings and loan holding company subject to stress testing on an annual or biennial basis: Ally Financial Inc.; American Express Company; Bank of America Corporation; The Bank of New York Mellon Corporation; The Charles Schwab Corporation; Citigroup Inc.; Citizens Financial Group, Inc.; Fifth Third Bancorp; The Goldman Sachs Group, Inc.; Huntington Bancshares Incorporated; JPMorgan Chase & Co.; KeyCorp; M&T Bank Corporation; Morgan Stanley; Northern Trust Corporation; The PNC Financial Services Group, Inc.; Regions Financial Corporation; State Street Corporation; Truist Financial Corporation; U.S. Bancorp; and Wells Fargo & Company. Return to text
Box 3. Effects of Securities Depreciation on Banks' Capital and Liquidity Positions
Securities holdings at banks rose to a record high in 2022, largely driven by the deposit surge that followed the onset of the pandemic (figure A).1 Banks added nearly $2.3 trillion in securities from the start of 2020 to the end of 2021, when interest rates were low.
As interest rates increased in 2022, the fair value of securities held by banks fell significantly. (The fair value of securities is generally inversely related to interest rates.) Securities depreciation attributable to available-for-sale securities resulted in $224 billion of unrealized losses as of June 30, 2022 (figure B).2 Unrealized losses on available-for-sale securities are included in accumulated other comprehensive income, reducing banks' tangible book value. Lower tangible book value can adversely affect stock price valuation in periods of stress or market participants' capital assessments. For some large banks, these unrealized losses also reduce their regulatory capital.
In addition, liquidity regulations require certain large banks to hold a prescribed level of liquid assets. Eligible securities are included in the calculation of liquid assets at their fair value. As a result, these large banks saw their liquid asset buffers decline because of the loss in value of eligible securities. However, large banks continue to meet their regulatory liquidity requirements.
Figure A. Deposits and securities (amortized cost)
Accessible Version | Return to text
Note: Domestic deposits only.
Source: Call Report and FR Y-9C.
Figure B. Net unrealized gains (losses) on available-for-sale securities
Accessible Version | Return to text
Note: Net unrealized gains (losses) are computed as fair value less amortized cost.
Source: Call Report and FR Y-9C.
1. Securities include U.S. Treasury securities, U.S. government agency and sponsored agency obligations, securities issued by states and political subdivisions in the United States, mortgage-backed securities, asset-backed securities, structured financial products, and other debt securities. Securities held for trading are excluded. Return to text
2. The depreciation of securities does not result in realized losses unless the securities are sold. Return to text
References
1. See Board of Governors of the Federal Reserve System, "Federal Reserve Board Releases Results of Annual Bank Stress Test, which Show that Banks Continue to Have Strong Capital Levels, Allowing Them to Continue Lending to Households and Businesses during a Severe Recession," news release, June 23, 2022, https://www.federalreserve.gov/newsevents/pressreleases/bcreg20220623a.htm. Return to text
2. In the Federal Reserve's H.8 release, "Assets and Liabilities of Commercial Banks in the United States," the "other loans" category includes loans to nondepository financial institutions and loans not categorized elsewhere. Return to text
3. See the Board of Governors of the Federal Reserve System, "Senior Loan Officer Opinion Survey on Bank Lending Practices," July 2022, at https://www.federalreserve.gov/data/sloos/sloos-202207.htm. Return to text
4. As of the second quarter of 2022, about one-third of the industry's credit loss reserves for loans and leases were allocated to credit cards. Return to text
5. See the May 2022 "Senior Financial Officer Survey" at https://www.federalreserve.gov/data/sfos/may-2022-senior-financial-officer-survey.htm. Return to text
6. While unrealized losses on available-for-sale securities are not included in CET1 capital for most other banks, these losses reduced banks' tangible book value, as described in box 3. Return to text
7. Under the Federal Reserve's capital rules, loans are generally assigned higher risk weights relative to other assets such as cash and securities. Return to text