As interest rates soar to heights not seen in over two decades and inflation continues to pressure consumers, major banks are gearing up to navigate potential risks associated with their lending practices.
In the second quarter of this year, 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 that banks set aside to cover possible losses arising from credit risks, such as delinquent loans and bad debts, particularly in commercial real estate.
Specifically, JPMorgan set aside $3.05 billion for credit losses; Bank of America accumulated $1.5 billion; Citigroup’s allowance for credit losses reached $21.8 billion—more than tripling its reserve build from the previous quarter; and Wells Fargo reported provisions of $1.24 billion.
These increased reserves indicate that banks are bracing for a riskier lending environment, as both secured and unsecured loans may result in larger losses for some of the country’s biggest financial institutions. According to a recent analysis from the New York Fed, Americans now owe a staggering $17.7 trillion across various consumer loans, student loans, and mortgages.
Furthermore, there is a notable rise in credit card issuance and delinquency rates as consumers exhaust their pandemic-era savings and increasingly rely on credit. As of the first quarter of this year, total credit card balances exceeded $1 trillion for the second consecutive quarter, as reported by TransUnion. The commercial real estate market continues to face uncertainties as well.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, pointed out that the banking sector is still recovering from the impacts of the COVID-19 pandemic, emphasizing that much of the support during this period came from consumer stimulus efforts.
However, challenges for banks may arise in the upcoming months. “The provisions you see each quarter do not necessarily reflect the credit quality from the past three months; they rather show banks’ expectations for the future,” explained Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
He noted a significant shift in how banks assess credit losses—moving from a model that increased provisions in response to loan defaults to one primarily influenced by macroeconomic projections.
In the short term, banks anticipate slowing economic growth, higher unemployment rates, and potential interest rate cuts later in the year, which may lead to increased delinquencies and defaults.
Citi’s chief financial officer, Mark Mason, highlighted that rising red flags appear to be more prevalent among lower-income consumers, whose savings have diminished since the pandemic.
“While we see an overall resilient U.S. consumer, there’s a divergence in performance across different income levels,” Mason indicated during a recent analyst call. He noted that only the highest income quartile has managed to maintain more savings than at the start of 2019, and it is primarily those with high credit scores driving spending growth and maintaining prompt payments. Meanwhile, consumers in lower credit score brackets are experiencing significant declines in payment rates and an increase in borrowing, impacted severely by high inflation and interest rates.
The Federal Reserve has held interest rates at a peak of 5.25-5.5% in its efforts to stabilize inflation towards a target of 2% before deciding on much-anticipated rate cuts.
Despite banks preparing for potential increased defaults in the latter half of the year, current default rates do not suggest an imminent consumer crisis. Mulberry is particularly observing the differences between homeowners and renters during this period: “While rates have risen significantly, homeowners secured low fixed rates on their debts and are not feeling the strain as acutely,” he noted. In contrast, renters who did not experience the same opportunities face increased stress due to soaring rents, which have risen by over 30% nationwide since 2019.
Nevertheless, the recent earnings reports indicate that the banking sector’s asset quality remains stable. Narron stated, “This quarter did not present any new challenges in asset quality,” highlighting that strong revenue, profit figures, and resilient net interest income are encouraging signs for the health of the banking industry.
“There is strength within the banking sector, which might not have been completely anticipated, but it’s a relief to see that the financial system’s structures are standing strong at this time,” Mulberry concluded. “However, we remain vigilant; prolonged high-interest rates could escalate stress within the sector.”