As interest rates remain at their highest levels in over two decades and inflation continues to impact consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, prominent banks such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo elevated their provisions for credit losses compared to the previous quarter. These provisions are meant to cover potential losses from credit risks, including bad debts and loans, especially in commercial real estate.
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 previous reserves, and Wells Fargo put away $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging economic landscape, where both secured and unsecured loans may lead to higher losses. A recent New York Fed analysis revealed that Americans collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
The issuance of credit cards and rising delinquency rates are becoming a concern as individuals exhaust their pandemic-era savings and increasingly depend on credit. According to TransUnion, credit card balances rose to $1.02 trillion in the first quarter of this year—the second consecutive quarter exceeding the trillion-dollar mark. Commercial real estate also remains under pressure.
Experts note that these challenges stem from lingering effects of the COVID-19 pandemic and the extensive government stimulus provided during that time. Brian Mulberry, a client portfolio manager at Zacks Investment Management, emphasized the ongoing impact on the banking sector and consumer health.
Looking ahead, analysts warn that current provisions may not accurately reflect the immediate credit quality but rather bank expectations for future performance. Mark Narron, a senior director at Fitch Ratings, highlighted this shift from a historical approach of tying provisions to loans going bad to a model driven by economic forecasts.
In the near future, banks anticipate slower economic growth, higher unemployment rates, and potential interest rate cuts later this year, which could lead to increased delinquencies and defaults by year-end.
Citigroup’s CFO, Mark Mason, pointed out that financial strain seems to be concentrated among lower-income consumers who have seen their savings diminish post-pandemic. He noted that only the highest income quartile has more savings than they did at the beginning of 2019, while lower-income individuals are facing greater financial challenges due to rising inflation and interest rates.
Despite the banks’ preparations for potential defaults in the latter half of the year, current default rates have not yet escalated to alarming levels, according to Mulberry. He emphasized the contrast between homeowners, who locked in low fixed rates during the pandemic, and renters, who are now facing much higher rents and costs without similar protections.
While grocery costs have surged by 25% and rents increased by more than 30% nationwide from 2019 to 2023, it is primarily renters who find themselves under the most financial strain.
For now, bank earnings have demonstrated stability, indicating no significant new issues in asset quality. Strong revenues, profits, and healthy net interest income reflect a resilient banking sector. Analysts remain cautiously optimistic, noting that while the banking system shows strength, the long-term impact of high interest rates must be monitored closely.