Amid interest rates reaching a 23-year high and ongoing inflation pressures on consumers, major banks are bracing for potential risks in their lending operations. In the second quarter of the year, leading banks—including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo—have all increased their reserves for credit losses compared to the previous quarter. These reserves are intended to cover potential losses related to credit risks, including defaults on loans.
JPMorgan set aside $3.05 billion for credit losses, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses surged to $21.8 billion, more than tripling its reserves from the prior quarter. Wells Fargo reported provisions of $1.24 billion.
These increased provisions indicate that banks are preparing for a riskier economic climate, where both secured and unsecured loans could lead to larger losses. The New York Federal Reserve recently highlighted that American households collectively owe $17.7 trillion in consumer, student, and mortgage debts.
Additionally, credit card issuance and delinquency rates are on the rise as many consumers exhaust their pandemic-era savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter that totals exceeded the trillion-dollar threshold, as reported by TransUnion. The commercial real estate sector also remains in a vulnerable position.
Brian Mulberry, a portfolio manager at Zacks Investment Management, noted that the banking sector is still recovering from the effects of the COVID-19 pandemic, largely due to government stimulus efforts. He emphasized that any challenges banks may face are likely in the months ahead.
Mark Narron, a senior director at Fitch Ratings, explained that the provisions shown in any given quarter do not necessarily reflect past credit quality but rather banks’ expectations for future performance. He pointed out the shift in banking practices from historically reacting to loan defaults to proactively adjusting reserves based on macroeconomic forecasts.
In the near future, banks anticipate slowing economic growth, rising unemployment, and two potential interest rate cuts later this year, which could lead to increased delinquencies and defaults as the year concludes.
Citigroup CFO Mark Mason highlighted that warning signs are particularly evident among lower-income consumers, who have seen their savings deplete since the pandemic. He reported that only the top income quartile has managed to retain more savings compared to early 2019, with higher credit score customers driving spending growth, while those with lower scores are experiencing declines in payment rates and rising borrowing costs.
The Federal Reserve remains committed to maintaining interest rates between 5.25% and 5.5% until inflation stabilizes at its 2% target, making any anticipated rate cuts a future consideration.
Despite preparations for a potential rise in defaults later in the year, current default rates do not signal an impending consumer crisis, according to Mulberry. He noted a key distinction between homeowners, who locked in low fixed mortgage rates, and renters, who have faced significant rent increases—over 30% from 2019 to 2023—along with grocery costs up 25%. Renters without the advantage of locked rates are increasingly burdened by their monthly expenses.
Overall, the most recent earnings reports indicate that there have been no significant changes in asset quality, according to Narron. The banking industry appears resilient, with strong revenues, profits, and net interest income suggesting a robust sector. Mulberry expressed cautious optimism, stating that while the banking system remains strong, the sustained high-interest rates could lead to more stress in the future.