Major banks are bracing for increased risks in their lending practices as interest rates hit their highest levels in over 20 years and inflation continues to pressure consumers.
In the second quarter of the year, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions represent funds set aside to cover potential losses from credit risks, including delinquency on loans and bad debts, particularly commercial real estate (CRE) loans.
JPMorgan allocated $3.05 billion for credit losses; Bank of America set aside $1.5 billion; Citigroup’s reserves reached $21.8 billion, significantly up from the previous quarter; and Wells Fargo reported provisions of $1.24 billion.
These increased reserves reflect the banks’ preparations for a riskier environment where both secured and unsecured loans may lead to larger losses. A recent analysis from the New York Fed highlighted that American households are in debt to the tune of $17.7 trillion from various loans, including consumer and student loans, as well as mortgages.
Additionally, the issuance of credit cards and delinquency rates are rising, as many consumers exhaust their savings accumulated during the pandemic and increasingly rely on credit. In the first quarter of the year, total credit card balances reached $1.02 trillion, marking the second consecutive quarter where this figure topped the trillion-dollar mark, according to TransUnion. Meanwhile, the CRE sector remains vulnerable.
As Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted, the banking industry’s condition is still evolving post-pandemic, largely influenced by the stimulus measures that aided consumers.
Experts caution that any banking issues are likely to surface in the coming months. According to Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, the provisions set aside by banks do not merely reflect historical credit quality but are rather predictive of expected future conditions.
Looking ahead, banks foresee a slowdown in economic growth, an increase in unemployment, and a couple of interest rate cuts anticipated in September and December, all of which could lead to more delinquencies and defaults as the year concludes.
Citi’s CFO Mark Mason observed that the warning signs are most prominent among lower-income consumers, who have seen their savings decline since the pandemic. He mentioned that while the overall U.S. consumer remains resilient, disparities in spending and payment behaviors are evident across different income and credit score bands.
As the Federal Reserve maintains interest rates at a 23-year high of 5.25-5.5%, waiting for inflation to stabilize around its 2% target, banks remain cautious about future default rates. However, Mulberry noted that current default rates have not yet reached levels indicative of a consumer crisis.
He pointed out the differences between homeowners who benefited from low fixed-rate mortgages during the pandemic and renters who have faced spiraling rental costs, which have surged by over 30% nationwide since 2019. Renters, in particular, are feeling the financial strain with rapid increases in rental prices that outpace wage growth.
Despite these challenges, the overall financial health of the banking sector appears robust based on the latest earnings reports. Narron remarked that there were no significant new concerns regarding asset quality, as strong revenues and profits continue to reflect a sound banking system. Mulberry added that while the banking sector shows resilience, the prolonged period of high interest rates could incite further stress.