As interest rates reach their highest levels in over 20 years and inflation continues to put pressure on consumers, major banks are bracing for heightened risks in their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their reserves for credit losses compared to the previous quarter. These reserves, set aside to cover potential losses from credit risks such as bad debts and lending issues, indicate that the banks are preparing for a more challenging economic environment.
JPMorgan allocated $3.05 billion for credit losses, Bank of America set aside $1.5 billion, Citigroup’s credit loss reserves rose to $21.8 billion—more than tripling from the previous quarter—and Wells Fargo added $1.24 billion.
These increased reserves indicate that banks are anticipating a riskier lending environment, which may lead to greater losses from both secured and unsecured loans. A recent analysis by the New York Federal Reserve highlighted that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are on the rise as consumers deplete their pandemic-era savings and increasingly turn to credit. According to TransUnion, credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total balances surpassed the trillion-dollar threshold. The commercial real estate sector also remains vulnerable.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the financial health of consumers has been significantly influenced by the stimulus measures implemented during the COVID-19 pandemic.
Mark Narron, a senior director at Fitch Ratings, noted that the provisions set aside by banks in any quarter do not solely reflect recent credit quality; instead, they anticipate future conditions.
He pointed out a shift in the banking system from a model where provisions increased with bad loans to one where macroeconomic forecasts drive provisioning decisions. In the short term, banks are expecting slower economic growth, rising unemployment, and two planned interest rate cuts in September and December, which could lead to increased delinquencies and defaults by the year’s end.
Citigroup’s CFO, Mark Mason, emphasized that economic concerns appear focused on lower-income consumers who have seen their savings diminish over the past few years. He observed that only the highest income quartile has managed to maintain greater savings since 2019, while consumers with lower credit scores are struggling more acutely with high inflation and interest rates.
The Federal Reserve continues to maintain interest rates at a 23-year high of 5.25-5.5%, awaiting signs that inflation will stabilize toward its target of 2% before implementing expected rate cuts.
Despite preparations for potential defaults in the latter half of the year, Mulberry pointed out that defaults are not rising at alarming rates that would suggest a consumer crisis. He noted a significant difference in experiences between homeowners and renters since the pandemic. Homeowners, who locked in low fixed rates on their mortgages, are largely shielded from current economic pressures, whereas renters face substantial increases in rent, which have outpaced wage growth.
Overall, the recent earnings reports from banks indicate stability within the banking sector, with no major concerns regarding asset quality. Positive metrics such as strong revenues and net interest income suggest ongoing health in the industry, although experts warn that persistent high interest rates may increase stress in the future.