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 strategies.
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. This increase in reserves is intended to cover potential losses from credit risks, including delinquent debts and loans such as commercial real estate 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—over three times its previous quarter’s reserves—and Wells Fargo reported provisions of $1.24 billion.
These elevated reserves reflect the banks’ preparations for a potentially riskier lending environment where both secured and unsecured loans could lead to greater losses. According to an analysis by the New York Federal Reserve, total consumer debt in the U.S. has reached $17.7 trillion, encompassing consumer loans, student debt, and mortgages.
Additionally, credit card usage has been on the rise, leading to increasing delinquency rates as many consumers lean heavily on credit in the wake of dwindling pandemic-era savings. Credit card balances have surpassed $1 trillion for the second consecutive quarter, signaling growing debt among borrowers. The commercial real estate sector is also facing challenges.
According to Brian Mulberry, client portfolio manager at Zacks Investment Management, the banking sector is still emerging from the impacts of the COVID-19 pandemic, shaped largely by the economic stimulus provided to consumers.
However, experts like Mark Narron from Fitch Ratings emphasize that the provisions banks report reflect expectations of future credit risks rather than past performance. This shift indicates that banks are increasingly influenced by macroeconomic forecasts when assessing potential risks.
In the short term, banks anticipate slowing economic growth, a rise in unemployment, and expected interest rate cuts later this year. This scenario could lead to an increase in loan delinquencies and defaults as the year progresses.
Citi’s CFO Mark Mason highlighted that the concerns about credit quality are particularly focused on lower-income consumers, who are experiencing significant financial strain since the pandemic.
While the overall U.S. consumer remains resilient, Mason noted a disparity in financial health across different income levels and credit scores. Only the highest income group has seen an increase in savings since early 2019, while lower-income consumers are facing greater challenges, including falling payment rates and reliance on credit.
The Federal Reserve’s interest rates currently remain at a 23-year peak of 5.25-5.5%, with the central bank awaiting inflation indicators to stabilize before commencing any anticipated rate cuts.
Despite banks preparing for higher default rates in the latter part of the year, Mulberry reassures that current default rates are not yet indicative of a broader consumer crisis. He pointed out differences between homeowners and renters, noting that while homeowners have locked in low fixed rates, renters—who have seen rental prices rise significantly—are bearing the brunt of increased living costs.
Overall, the recent earnings reports indicate that there are no alarming new developments regarding asset quality. Continued strong revenues, profits, and stable net interest income suggest that the banking sector remains fundamentally healthy, although prolonged high interest rates could introduce further stress.