As interest rates remain at their highest levels in over 20 years and inflation continues to impact consumers, major banks are bracing for increased risks linked to their lending activities.
In the second quarter of this year, major banks including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo raised their reserves for credit losses compared to the previous quarter. These reserves are intended to cover potential losses arising from credit risks like bad debts and delinquent loans.
JPMorgan set aside $3.05 billion for credit losses during the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s credit loss allowance reached $21.8 billion, marking more than a threefold increase in its reserves from the previous quarter. Wells Fargo provided $1.24 billion for credit losses.
These increased reserves indicate that banks are preparing for a potentially riskier lending atmosphere, where both secured and unsecured loans could lead to larger losses. A recent analysis from the New York Fed revealed that American households carry a collective debt of $17.7 trillion, which includes consumer loans, student loans, and mortgages.
Credit card issuance, along with rising delinquency rates, reflects consumers’ reliance on credit as their pandemic savings diminish. Total credit card balances reached $1.02 trillion in the first quarter, making it the second consecutive quarter that the combined balances surpassed the trillion-dollar mark, according to TransUnion. Additionally, the commercial real estate sector remains under considerable pressure.
Experts highlight that the effects of the pandemic and subsequent government stimulus measures have significantly influenced current consumer behavior and banking health. Brian Mulberry of Zacks Investment Management noted that we are emerging from the COVID era, and the consequences on economic conditions must be closely monitored.
“The provisions disclosed in each quarter reflect banks’ expectations for future credit quality, not just recent trends,” explained Mark Narron from Fitch Ratings. He noted a shift from a historical system where failing loans drove reserve increases to a model more influenced by macroeconomic forecasts.
In the short term, banks are predicting slower economic growth, rising unemployment, and anticipated interest rate cuts later this year, which may lead to additional delinquencies and defaults.
Citi’s CFO, Mark Mason, pointed out that the potential financial strain appears to be concentrated among lower-income consumers, whose savings have diminished post-pandemic. He observed a notable divide in financial resilience among consumers, with only the highest-income quartile maintaining increased savings since 2019. Customers with top credit ratings are still managing to sustain spending and keeping their payment rates high, in contrast to lower-rated borrowers who are facing challenges.
The Federal Reserve has kept interest rates high, between 5.25% and 5.5%, while awaiting stabilization in inflation to achieve its 2% target before implementing any significant rate cuts.
Although banks are preparing for greater default risks in the latter part of the year, the current default rates do not yet indicate a consumer crisis. Mulberry indicated a key area to watch will be the difference in experiences between homeowners and renters during the pandemic. Homeowners generally locked in low fixed-rate mortgages, insulating them from current financial pressures, whereas renters who did not benefit from such conditions are facing heightened stress due to surging rental prices.
Despite concerns, the latest earnings reports show that asset quality remains stable, with strong revenue growth, profits, and resilient net interest incomes signaling a still-healthy banking sector. According to Mulberry, the stability of the financial system remains a positive takeaway, although continued high interest rates may introduce more stress in the future.