As interest rates remain at their highest in over two decades and inflation continues to impact consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter of this year, major financial institutions including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions, which serve as a financial cushion for potential losses from credit risks—such as bad debt or defaulted loans—have seen significant upticks across these banks.
JPMorgan set aside $3.05 billion for credit losses, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses climbed to $21.8 billion by the end of the quarter, marking a tripling of its previous credit reserve, and Wells Fargo reported provisions of $1.24 billion.
These increased provisions indicate that banks are preparing for a possibly riskier lending environment where both secured and unsecured loans could lead to greater losses. A recent study by the New York Federal Reserve revealed that U.S. households collectively owe $17.7 trillion in consumer debt, including mortgages and student loans.
Credit card use is also on the rise, with delinquency rates climbing as consumers deplete their pandemic-related savings and turn more frequently to credit. Credit card balances hit $1.02 trillion in the first quarter of this year, making it the second consecutive quarter where total cardholder balances exceeded this threshold, according to data from TransUnion. Additionally, commercial real estate lending remains vulnerable.
Brian Mulberry from Zacks Investment Management noted that the banking industry is still recovering from the impact of COVID-19, heavily influenced by the stimulus measures that were introduced.
However, banks anticipate that any significant challenges will emerge in the coming months. Mark Narron of Fitch Ratings indicated that the provisions reported in any given quarter typically reflect the banks’ outlook for the future, rather than past credit quality.
In the short term, banks expect economic growth to slow, unemployment rates to rise, and potential interest rate cuts later this year, which could contribute to increased delinquencies and defaults by year’s end.
Citi’s CFO Mark Mason highlighted that the concerns are primarily among lower-income consumers, who have struggled to maintain savings during the post-pandemic period.
He pointed out that while the overall U.S. consumer remains resilient, there is a notable divergence in financial health based on income levels. Only the highest income brackets have managed to retain more savings than they had pre-pandemic, while those in lower credit score ranges face declining payment rates and are increasingly borrowing due to the pressures of high inflation and interest rates.
The Federal Reserve is maintaining interest rates at a 23-year high of 5.25-5.5%, waiting for inflation to stabilize around its 2% target before implementing anticipated rate cuts.
Despite banks preparing for an uptick in defaults in the latter half of the year, Mulberry suggests that default rates have not yet escalated to a level indicative of a consumer crisis. He notes a significant difference in experiences between homeowners and renters since the pandemic began.
Though interest rates have increased, homeowners who secured low fixed-rate mortgages are relatively insulated from these changes. In contrast, renters, who have seen rental prices rise by over 30% and grocery costs increase by 25% from 2019 to 2023, are experiencing greater financial strain.
Overall, the most recent earnings reports reveal that asset quality remains stable, and strong revenues and profits indicate a resilient banking sector. Mulberry expressed relief that the financial system remains robust, but he cautioned that prolonged high-interest rates could lead to increased stress in the banking sector.