As interest rates reach their highest levels in over two decades and inflation continues 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 are funds that banks set aside to cover potential losses from credit risks, including bad debts and delinquent loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s allowance for credit losses rose to $21.8 billion, more than tripling its credit reserve from the previous quarter; and Wells Fargo earmarked $1.24 billion.
This buildup indicates that banks are preparing for a more challenging environment, where both secured and unsecured loans may result in greater losses. A recent analysis from the New York Fed revealed that total household debt in the U.S. has reached approximately $17.7 trillion, which includes consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as consumers begin to exhaust their pandemic-era savings and increasingly rely on credit. Credit card debt reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar mark. The commercial real estate sector remains particularly vulnerable as well.
“We’re still recovering from the COVID era, and much of it has been supported by stimulus to consumers,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, potential bank challenges are anticipated in the coming months.
“The provisions reported for any given quarter don’t necessarily reflect recent credit quality but rather what banks forecast for the future,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
He noted a shift from a historical system, where rising defaults led to increased provisions, to one that is now influenced primarily by macroeconomic forecasts.
Currently, banks expect slower economic growth, higher unemployment rates, and two planned interest rate cuts later this year, which could lead to greater delinquencies and defaults by year-end.
Citigroup’s chief financial officer, Mark Mason, highlighted that the risks appear concentrated among lower-income consumers, who have seen their savings decline since the pandemic.
“While we’re witnessing overall resilience in the U.S. consumer, there’s a noticeable disparity in performance and behavior across income levels and credit scores,” Mason explained during a recent analyst call. He pointed out that only those in the highest income quartile have maintained their savings since early 2019, with higher credit score customers driving spending growth and maintaining consistent payment habits.
Meanwhile, consumers with lower credit scores are experiencing sharper declines in payment rates and are relying more heavily on credit, impacted significantly by high inflation and rising interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, waiting for inflation measures to stabilize before enacting anticipated rate cuts.
Despite the preparations for potential defaults later this year, Mulberry noted that defaults have not yet reached a level indicative of a consumer crisis. He is monitoring the distinction between homeowners and renters from the pandemic period.
“Homeowners secured low fixed rates on their debts, so they aren’t feeling the same pressure, whereas renters didn’t have that opportunity,” Mulberry said. Rent prices have surged over 30% nationwide between 2019 and 2023, coupled with a 25% increase in grocery costs during the same timeframe. This situation has created significant financial strain for renters whose rental expenses have outpaced wage growth.
Ultimately, the latest earnings reports indicate that there have been no significant new concerns regarding asset quality. Strong revenues, profits, and robust net interest income suggest a still-healthy banking sector.
“There is resilience within the banking sector that may have been unexpected, but it’s reassuring to see that the financial system remains solid,” Mulberry concluded. “However, we are closely monitoring the situation, as prolonged high interest rates can lead to increased stress.”