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 in their lending practices. In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their credit loss provisions compared to the previous quarter. These provisions are funds set aside by banks to manage potential losses stemming from credit risks, which include delinquent debt and commercial real estate loans.
In this latest quarter, JPMorgan allocated $3.05 billion for credit losses, Bank of America set aside $1.5 billion, Citigroup’s allowance rose to $21.8 billion—more than triple its previous quarter’s reserve—and Wells Fargo reported $1.24 billion in provisions. This increase indicates that banks are preparing for a riskier economic environment, where both secured and unsecured loans may lead to larger losses.
A study by the New York Fed found that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages. Credit card issuance is also rising, with delinquency rates climbing as many consumers deplete their savings from the pandemic and increasingly rely on credit. Recent data revealed credit card balances reached $1.02 trillion in the first quarter of the year, marking the second consecutive quarter in which total balances surpassed this threshold. The outlook for commercial real estate remains uncertain.
Analysts suggest these issues are part and parcel of the ongoing recovery from the COVID-19 pandemic, driven largely by consumer stimulus measures. However, the implications for banks may manifest in the upcoming months.
“The provisions displayed in any quarter don’t necessarily reflect recent credit quality but rather what banks anticipate for the future,” explained Mark Narron from Fitch Ratings. He noted a shift from traditional models where increased loan defaults would trigger higher provisions, to a new reality where macroeconomic forecasts dictate these provisions.
In the short term, banks forecast slowing economic growth, a rise in unemployment, and anticipate rate cuts in September and December. These factors could lead to more delinquencies and defaults as the year progresses. Citigroup’s financial officer, Mark Mason, highlighted that the greatest economic strain is being felt among lower-income consumers, who have seen their savings diminish significantly since the pandemic.
Mason observed that while the overall U.S. consumer appears resilient, there is a clear divergence in financial health across different income brackets. Only higher-income households have retained more savings compared to early 2019, and they are the ones primarily driving growth in spending and payment rates. Conversely, consumers in lower income categories are experiencing declines in payment rates and are borrowing more to cope with high inflation and rising interest rates.
The Federal Reserve has maintained interest rates in the range of 5.25% to 5.5%, a 23-year high, awaiting stabilization in inflation metrics toward its 2% target before considering anticipated rate cuts.
Despite the preparation for an increase in defaults later this year, current rates of default do not indicate an imminent consumer crisis, according to analyst Brian Mulberry. He emphasized the distinction between homeowners, who benefitted from low fixed-rate mortgages, and renters, who are facing significant financial strain due to escalating rent costs.
Given that national rents have surged over 30% from 2019 to 2023, and grocery prices have risen 25% in the same timeframe, renters are now feeling the greatest pressure on their budgets, especially when their wage growth has not kept pace.
For now, the latest earnings reports have signaled that the banking sector remains strong, with many indicators such as revenue and profit levels suggesting healthy operations. However, experts are carefully monitoring the situation, noting that prolonged periods of high interest rates could lead to more financial stress in the future.