Banks Brace for a Credit Crunch: What’s Coming Next?

With interest rates reaching highs not seen in over 20 years and inflation putting pressure on consumers, major banks are bracing for increased risks linked to their lending activities.

In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses. These provisions represent funds set aside by financial institutions to cover potential losses associated with credit risk, including overdue payments or bad debts, particularly in the commercial real estate sector.

JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, more than tripling its reserves from the previous quarter. Wells Fargo included $1.24 billion in provisions.

These reserves indicate that banks are anticipating a challenging lending environment, where both secured and unsecured loans could lead to greater losses. A recent study by the New York Federal Reserve revealed that Americans have a combined debt of $17.7 trillion in consumer loans, student loans, and mortgages.

Credit card usage and delinquency rates are also climbing, as individuals’ savings from the pandemic decrease and their reliance on credit increases. Total credit card balances hit $1.02 trillion in the first quarter of the year, marking the second consecutive quarter where balances surpassed the trillion-dollar threshold, according to TransUnion. Additionally, commercial real estate still faces uncertainties.

“We’re still recovering from the COVID era, especially regarding banking and consumer health, and much of that was driven by the stimulus provided to consumers,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.

Challenges for banks may arise in the coming months. “The provisions recorded in a given quarter don’t solely reflect credit quality from that period; they also indicate what banks anticipate happening in the future,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.

Interestingly, there has been a shift from a system where rising loan defaults triggered increased provisions to one where macroeconomic forecasts largely influence provisioning.

Looking ahead, banks forecast a slowdown in economic growth, a rise in unemployment, and potential interest rate cuts later this year in September and December, which could lead to more delinquencies and defaults as the year ends.

Citigroup’s CFO Mark Mason highlighted that the warning signs seem to be concentrated among lower-income consumers, who have seen their savings diminish since the pandemic. “While we observe an overall resilient U.S. consumer, there’s a noticeable divergence in performance and behavior across income and credit score groups,” Mason stated in a recent analyst call.

The Federal Reserve has maintained interest rates at a 23-year peak of 5.25-5.5%, awaiting signs of inflation stabilizing towards its 2% target before implementing any anticipated rate reductions.

Despite banks preparing for increased defaults, current defaults are not climbing at a rate indicating an imminent consumer crisis, according to Mulberry. He is particularly interested in the differences between homeowners and renters during the pandemic.

“Yes, rates have increased significantly since then, but homeowners secured very low fixed rates on their debts, so they aren’t feeling the squeeze. Renters, on the other hand, didn’t have that opportunity.”

With rents up more than 30% and grocery costs rising 25% between 2019 and 2023, renters who couldn’t secure low rates are now experiencing the most financial distress.

For the time being, the key takeaway from the recent earnings reports is that “there was nothing new this quarter regarding asset quality,” Narron noted. Strong revenues, profits, and resilient net interest income suggest a banking sector that remains fundamentally healthy.

“There’s a considerable strength in the banking sector that might not have been wholly unexpected, but it’s reassuring to confirm that the foundations of the financial system remain robust,” Mulberry commented. “However, we are monitoring the situation closely, as prolonged high interest rates will continue to apply pressure.”

Popular Categories


Search the website