As interest rates reach their highest levels in over two decades and inflation continues to challenge consumers, major banks are preparing for increased 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 are designed to cover potential losses stemming from credit risk, including bad debt and loans, such as those related to commercial real estate.
Specifically, JPMorgan set aside $3.05 billion for credit losses in the second quarter; Bank of America allocated $1.5 billion; Citigroup’s allowance reached $21.8 billion, more than tripling its reserve from the previous quarter; and Wells Fargo’s provisions amounted to $1.24 billion.
These increases indicate that banks are bracing for a riskier financial environment, where both secured and unsecured loans may lead to higher losses. A recent analysis by the New York Federal Reserve revealed that American households carry a combined $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as consumers exhaust their pandemic savings and increasingly rely on credit. As of the first quarter of this year, credit card balances hit $1.02 trillion, marking the second consecutive quarter of exceeding this threshold, as reported by TransUnion. Additionally, commercial real estate remains in a vulnerable position.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking sector is still navigating the aftermath of the COVID era, emphasizing the role of consumer stimulus during that time.
However, challenges for the banks may increase in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that current provisions do not necessarily reflect recent credit quality but rather banks’ expectations for the future. This marks a shift from prior practices where rising provisions correlated directly with loans going bad.
In the short term, banks anticipate slower economic growth, higher unemployment rates, and possible interest rate cuts later this year, leading to potential increases in delinquencies and defaults.
Citi’s chief financial officer, Mark Mason, highlighted that warning signs seem particularly pronounced among lower-income consumers who have seen their savings diminish in the years following the pandemic.
Despite overall resilience among U.S. consumers, Mason pointed out a growing disparity in spending behavior across different income levels, with only the wealthiest quartile of consumers having increased their savings since early 2019. Consumers with lower credit scores are experiencing significant declines in payment rates and are borrowing more, heavily affected by high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting signs of stabilization in inflation before implementing anticipated rate cuts.
Although banks are preparing for a rise in defaults later in the year, current default rates do not indicate an impending consumer crisis, according to Mulberry. He noted a distinct difference between homeowners, who secured low fixed-rate mortgages during the pandemic, and renters, who have not had similar opportunities and are feeling the strain from rising rents.
Over the past few years, rental prices have surged over 30% nationwide, alongside a 25% increase in grocery costs, putting significant pressure on renters who have seen their wages grow at a slower rate.
At present, analysts suggest that the latest earnings reports show no major changes in asset quality. Positive revenue and profit metrics indicate a resilient banking sector, with an overall assessment pointing to a strong financial system. Mulberry noted, “The longer that interest rates remain at these elevated levels, the more stress it imposes.”