As interest rates reach their highest levels in over two decades and inflation continues to impact consumers, major banks are bracing for potential 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 represent the funds set aside by financial institutions to cover possible losses stemming from credit risks, including bad debts and loans in areas such as commercial real estate.
JPMorgan allocated $3.05 billion for credit loss provisions; Bank of America set aside $1.5 billion; Citigroup’s allowance reached $21.8 billion, reflecting a significant increase from previous quarters; and Wells Fargo’s provisions amounted to $1.24 billion.
These accumulated reserves indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans may lead to larger losses. A recent report by the New York Federal Reserve highlights that American households collectively owe $17.7 trillion in consumer, student, and mortgage loans.
Moreover, credit card usage and delinquency rates are also on the rise, as many people are depleting their pandemic-era savings and increasingly relying on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances surpassed this threshold, according to TransUnion. The commercial real estate sector is also facing significant uncertainties.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that banks are still recovering from the effects of COVID-19 and that the stimulus measures taken during the pandemic played a critical role in the consumer’s financial health.
However, the banking sector is anticipated to face challenges in the forthcoming months. According to Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, the provisions reported in any quarter may not accurately reflect the credit quality of the preceding three months, but instead what banks expect for the future.
He stated, “We’ve transitioned from a system where bad loans would increase provisions to a model driven by macroeconomic forecasts for provisioning.”
Banks are currently forecasting slower economic growth, increased unemployment, and potential interest rate cuts in September and December, which could lead to higher delinquency rates and defaults by year-end.
Citigroup’s CFO Mark Mason highlighted that these warning signs are especially poignant among lower-income consumers, who have seen a decline in savings since the pandemic began.
“While we see a resilient U.S. consumer overall, there is a noticeable divergence in performance across different income levels and credit scores,” Mason mentioned in a recent analyst call. He added that only the top income quartile has increased savings since 2019, while individuals with lower credit scores are experiencing more difficulty with payments and increased borrowing.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, waiting for inflation to stabilize towards its 2% target before enacting expected rate cuts.
Despite banks preparing for a potential rise in defaults later this year, current trends do not indicate a consumer crisis, according to Mulberry. He emphasized the importance of differentiating between homeowners from the pandemic era and renters facing rising costs.
While interest rates have surged, those who secured low fixed rates on their mortgages have not felt the same financial strain as renters, who have faced sharply increased rents—over 30% nationwide between 2019 and 2023—and grocery costs rising 25% during the same period.
For now, the key takeaway from recent earnings reports is that there have been no significant changes in asset quality. Reports indicate that strong revenues, profits, and robust net interest income reflect a still-stable banking sector.
“There’s strength in the banking sector that provides reassurance about the financial system’s soundness during this time,” Mulberry said. “However, prolonged high-interest rates could lead to increased pressure.”