Banks Brace for a Potential Credit Crisis: What You Need to Know

With interest rates at their highest level in over 20 years and inflation impacting consumers, major banks are gearing up to manage increased risks in their lending activities.

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 reflect funds set aside by banks to account for potential losses from issues such as delinquent debts and loans, including commercial real estate (CRE) loans.

JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s credit loss allowance reached $21.8 billion, significantly higher than the previous quarter; and Wells Fargo’s provisions amounted to $1.24 billion.

These provisions indicate that banks are preparing for a challenging environment where both secured and unsecured loans may lead to greater losses. A recent analysis from the New York Fed revealed that Americans collectively owe approximately $17.7 trillion in consumer loans, student loans, and mortgages.

Additionally, credit card issuance and delinquency rates are increasing as consumers exhaust their pandemic-era savings and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter in which total balances surpassed the trillion-dollar threshold, according to TransUnion. The CRE sector also remains under pressure.

According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, we are still emerging from the COVID-19 pandemic, which involved significant consumer stimulus.

However, challenges for banks are expected in the upcoming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported by banks in any given quarter reflect their expectations about future credit quality rather than solely the performance of loans in the past three months.

Banks anticipate a slowdown in economic growth, a rise in unemployment, and potential interest rate cuts later this year. This scenario could lead to further delinquencies and defaults as the year progresses.

Citi’s CFO Mark Mason pointed out that the issues seem to be primarily affecting lower-income consumers who have seen their savings decrease since the pandemic began. He noted that while the overall U.S. consumer remains resilient, there is a noticeable divergence in financial behavior across different income levels and credit scores.

Only the highest-income quartile has retained more savings than before 2019, and those with credit scores above 740 are mainly contributing to spending growth, whereas lower credit score customers are experiencing greater declines in payment rates and are borrowing more, severely impacted by rising inflation and interest rates.

The Federal Reserve currently maintains interest rates between 5.25% and 5.5%, the highest in 23 years, as it waits for inflation trends to stabilize around its 2% target before implementing any rate cuts.

Despite the banks bracing for a possible increase in defaults later this year, Mulberry noted that defaults have not escalated at a concerning rate, suggesting that a consumer crisis is not yet imminent. He is particularly monitoring the differences between homeowners and renters during this period.

Homeowners benefitted from securing low fixed-rate mortgages, insulating them from the impact of rising rates. In contrast, renters, who have faced over a 30% increase in rents from 2019 to 2023, along with a 25% rise in grocery costs, are feeling greater financial strain.

Currently, the overall financial health of the banking sector remains solid, with strong revenues and net interest income, providing reassurance amid concerns about asset quality. Mulberry expressed relief that the financial system continues to show strength, although the stress may increase the longer interest rates remain elevated.

Popular Categories


Search the website