With interest rates at their highest levels in over 20 years and inflation continuing to pressure consumers, major banks are bracing for increased risks associated with 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 represent the funds that banks set aside to cover potential losses from credit risk, including overdue debts and commercial real estate loans.
Specifically, JPMorgan allocated $3.05 billion for credit losses, Bank of America set aside $1.5 billion, Citigroup’s total allowance reached $21.8 billion—more than tripling its reserve build from the previous quarter—and Wells Fargo noted provisions of $1.24 billion.
These heightened reserves indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans could lead to greater losses. An analysis by the New York Federal Reserve revealed that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance is climbing, and delinquency rates are also on the rise as consumers begin to deplete their savings accrued during the pandemic and increasingly rely on credit. According to TransUnion, total credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter that total balances surpassed this threshold. Meanwhile, commercial real estate continues to face uncertain conditions.
“We’re still emerging from the COVID era, particularly regarding banking and consumer health, largely due to the stimulus provided to consumers,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, any issues for banks may emerge in the near future.
“The provisions you observe in any given quarter don’t directly reflect credit quality from the last three months; they indicate banks’ expectations for the future,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
He noted a shift in the banking system where macroeconomic forecasts now primarily drive provisioning rather than past loan performance.
Looking ahead, banks are anticipating slower economic growth, an increase in unemployment rates, and two expected interest rate cuts later this year in September and December, which could lead to more delinquencies and defaults as the year concludes.
Citi’s chief financial officer, Mark Mason, highlighted that these emerging concerns seem to be concentrated among lower-income consumers, who have seen their savings diminish since the pandemic.
“While the overall U.S. consumer remains resilient, we see a divergence in performance across different income and credit score groups,” Mason said during a recent analyst call.
“Only the highest income quartile has increased savings since early 2019, and it’s the highest credit score customers who are driving spending growth and maintaining high payment rates. Meanwhile, lower credit score clients are experiencing significant declines in payment rates and are borrowing more, feeling the strain of high inflation and interest rates.”
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization of inflation measures toward the central bank’s 2% target before implementing any anticipated rate cuts.
Despite banks bracing for potential increases in defaults later in the year, Mulberry suggests that current default rates do not yet indicate a looming consumer crisis. He observes a notable contrast between homeowners and renters during the pandemic.
“While rates have increased significantly, homeowners locked in very low fixed rates, so they aren’t experiencing the same pressures,” Mulberry noted. “Renters, however, have missed out on such opportunities.”
With rent prices increasing more than 30% nationally from 2019 to 2023 and grocery costs rising by 25% during the same period, renters who did not secure low rates are facing the most financial challenges, as their expenses outpace wage growth.
At present, the latest earnings reports suggest stability in the banking sector, according to Narron, with “no new developments in terms of asset quality.” Strong revenues, profits, and resilient net interest income are positive signals for the industry’s overall health.
“There’s some strength in the banking sector that may not have been entirely unexpected, but it’s reassuring to see that the foundations of the financial system remain solid,” Mulberry remarked. “However, we are keeping a close eye on the situation, as prolonged high interest rates could lead to increased stress.”