As interest rates reach their highest levels in over two decades and inflation continues to impact consumers, major banks are bracing for increased risks in their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions, which represent funds set aside to cover potential losses from credit risk, have become a focus as banks assess the potential for delinquent loans, including those in the commercial real estate sector.
JPMorgan Chase reported a provision for credit losses totaling $3.05 billion in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, marking a significant increase from the previous quarter, and Wells Fargo recorded provisions of $1.24 billion.
These increases indicate that banks are preparing for a more challenging lending environment, one where both secured and unsecured loans may result in greater losses. A recent analysis by the New York Federal Reserve revealed that U.S. households collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
Moreover, credit card issuance has risen sharply, leading to higher delinquency rates as Americans deplete their pandemic-era savings and lean more heavily on credit. In the first quarter of this year, credit card balances surpassed $1 trillion for the second consecutive quarter, according to TransUnion. The commercial real estate market also remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the ongoing effects of the pandemic and related financial stimulus on consumers. However, challenges for banks are anticipated in the coming months.
Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that the provisions for credit losses reflect banks’ expectations for the future rather than solely past performance.
Banks are forecasting slower economic growth, a rising unemployment rate, and potential interest rate cuts later in the year, which could lead to an increase in delinquencies and defaults as the year concludes.
Citi’s chief financial officer, Mark Mason, highlighted that emerging risks mainly affect lower-income consumers, whose savings have diminished in the aftermath of the pandemic. He stated that only the highest-income quartile has increased their savings since 2019, while customers with lower credit scores face declining payment rates and higher borrowing due to the pressures of elevated inflation and interest rates.
The Federal Reserve maintains interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation toward its 2% target before making any anticipated cuts.
At present, while banks are preparing for possible increased defaults, the current rate of defaults does not indicate a consumer crisis, according to Mulberry. He noted a significant distinction between homeowners and renters during this period. While homeowners typically benefited from locking in low fixed rates, renters have faced surging rental costs, which rose by over 30% from 2019 to 2023, along with a 25% increase in grocery prices, creating significant financial stress.
Despite these concerns, the recent earnings reports suggest stability in the banking sector, with strong revenues, profits, and net interest income. Narron remarked that the latest quarter did not reveal new issues in asset quality, and Mulberry echoed that the financial system remains resilient, although pressure increases the longer interest rates remain elevated.