As interest rates reach their highest point in over twenty years and inflation continues to pressure consumers, major banks are bracing for potential risks associated with their lending practices.
In the second quarter, top banks like JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds banks allocate to cover possible losses due to credit risk, including bad debts and various types of loans, such as those tied to commercial real estate.
JPMorgan set aside $3.05 billion, Bank of America increased its provisions to $1.5 billion, Citigroup’s allowance for credit losses grew to $21.8 billion—more than tripling its reserves since the last quarter—and Wells Fargo provisioned $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans may lead to larger losses. The New York Federal Reserve recently highlighted that U.S. households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Amidst dwindling pandemic-era savings, credit card issuance and delinquency rates have started to rise. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that overall cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. Additionally, the commercial real estate sector continues to face significant challenges.
Experts point out that the banking landscape is still adjusting from the COVID-19 period, largely influenced by the financial stimulus provided during that time. Brian Mulberry of Zacks Investment Management remarked on the lasting effects of these policies on consumer health.
While current provisions reflect banks’ expectations for the future rather than recent credit quality, analysts anticipate an economic slowdown, a rise in unemployment, and potential interest rate cuts later this year, which could result in increased delinquencies and defaults.
Citi’s CFO Mark Mason indicated that concerns about defaults are particularly pronounced among lower-income consumers, who are experiencing rapid declines in their savings since the pandemic. He noted that only the top income quartile has managed to save more compared to early 2019, with higher FICO score clients driving spending growth while lower-scoring customers struggle with payment rates amid inflated living costs.
The Federal Reserve has maintained interest rates at a two-decade high of 5.25-5.5% as it monitors inflation trends, aiming to reach its target of 2% before considering rate cuts.
Despite preparations for a rise in defaults later this year, current data do not indicate an imminent consumer crisis, according to Mulberry. He suggested that homeowners, who secured low fixed rates during the pandemic, may not feel as much financial strain as renters, who are facing significant increases in housing costs.
Despite rising interest rates, recent earnings reports suggest the banking sector remains healthy overall, with solid revenues, profits, and net interest income being positive signs. Mulberry emphasized that the financial system demonstrates resilience, although persistent high interest rates may lead to increased stress over time.