Banking System Conditions
The banking industry came into 2020 in a healthy financial position.
For the past decade, the Federal Reserve has worked intensively to promote a healthy and resilient banking sector. Regulatory and supervisory reforms, and additional measures taken by the banking industry, have improved the resilience of the core of the financial system. Banks are better capitalized and hold more liquidity. The industry is characterized by better capital and liquidity planning and improved risk-management capabilities at banks of all sizes. As a result, the banking industry entered the current crisis well positioned to support continued lending.
Strong capital positions enable institutions to absorb higher credit losses while continuing to lend through times of stress. The aggregate bank common equity tier 1 (CET1) capital ratio ended 2019 at a high level, close to 12 percent.2 As of year-end 2019, less than one-half of 1 percent of institutions were not well capitalized (figure 1).
Figure 1. Common equity tier 1 capital ratio/share of institutions not well capitalized
Note: Common equity tier 1 capital ratio is the ratio of tier 1 common equity to risk-weighted assets. See the data appendix for further information.
Source: Call Report and FR Y-9C.
Strong liquidity positions—high levels of cash and securities easily convertible to cash—enable financial institutions to meet their obligations to creditors and other counterparties, while continuing to support households and businesses. The banking industry's aggregate holdings of liquid assets remained high through the end of 2019 (figure 2). Financial institutions had also generated steady profits, positioning them well to support continued lending. Return on equity (ROE) and return on average assets (ROAA) have both seen significant improvement since 2010. The two measures ended 2019 well above their long-run averages (figure 3).
Figure 2. Liquid assets as a share of total assets
Note: Liquid assets are cash plus estimates of securities that qualify as high-quality liquid assets (HQLA) as defined by the liquidity coverage ratio requirement. Data include only firms that filed the FR Y-9C and exclude SLHCs.
Source: FR Y-9C.
Figure 3. Bank profitability
Note: ROAA is net income/quarterly average assets; ROE is net income/average equity capital.
Source: Call Report and FR Y-9C.
Deposit and loan balances have grown significantly.
Bank deposits and loans grew at extraordinary rates in March (figure 4). Bank deposits surged as investors favored safe assets and pulled back from other short-term investments such as prime money market funds. Strong growth in bank loans reflected a preference by business borrowers to seek liquidity as they responded to the current economic contraction. A significant portion of the growth in bank loans came from a drawdown of existing loan commitments. Outside of high growth in commercial and industrial loans, lending to other borrowers grew in March but to a much smaller extent (figure 5).
Figure 4. Deposit and loan growth (seasonally adjusted, annual rate)
Note: Growth rate is for annualized month-over-month change. Based on estimated weekly aggregate balance sheets for all commercial banks in the United States. Key identifies bars in order from left to right.
Source: H.8, "Assets and Liabilities of Commercial Banks in the United States."
Figure 5. Loan growth by sector (seasonally adjusted, annual rate)
Note: Growth rate is for annualized month-over-month change. Based on estimated weekly aggregate balance sheets for all commercial banks in the United States. Key identifies bars in order from left to right.
Source: H.8, "Assets and Liabilities of Commercial Banks in the United States."
Banks are facing significant operational challenges.
Depending on their size, complexity, and geographic location, banks are facing differing levels of operational challenges as a result of current governmental containment measures. In response to social distancing measures, many banks have reduced or eliminated access to branch lobbies, but continue to transact with customers via drive-through tellers or online and mobile channels. Some have temporarily decreased hours or closed certain branch locations. Many banks have drawn on business continuity plans to allow employees to work from home. Banks with an international presence (either branch or back office operations) have had to navigate local government restrictions on activity.3
First quarter earnings declined sharply.
In the first quarter of 2020, large U.S. bank earnings declined sharply. Based on a sample of large banks reporting in April, earnings declined more than 50 percent compared with the first quarter of 2019. Substantially higher loan loss provisions accounted for almost all of the decline, as revenues were roughly flat.4 Higher provisions were driven both by weaker economic forecasts by banks and by implementation of the new current expected credit loss (CECL) accounting standard.5 Reserve builds and charge-offs occurred across both corporate and consumer loans, with energy-related credits and credit cards subject to sizable provisioning.
Capital levels declined, driven primarily by increases in risk-weighted assets.
Most large U.S. banks reported slightly lower CET1 capital ratios for the first quarter of 2020 but still significantly exceeded regulatory requirements (figure 6). For the 22 domestic bank holding companies with assets greater than $100 billion, this ratio in aggregate declined from 11.5 percent at the end of the fourth quarter of 2019 to 11.0 percent at the end of the first quarter of 2020. Strong growth in risk-weighted assets, the denominator of the CET1 capital ratio, rather than reductions in the actual amount of capital, was the main driver of lower capital ratios. The increase in risk-weighted assets was a result of increased lending in the first quarter. Large firms have suspended share buybacks in order to preserve capital.
Figure 6. Aggregate common equity tier 1 capital ratio for large bank holding companies (BHCs) (total assets > $100 billion)
Note: Data include all domestic BHCs with assets greater than $100 billion as of 2020:Q1 (JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs Group, Morgan Stanley, Bank of New York Mellon, State Street, U.S. Bancorp, Truist Financial, PNC Financial Services Group, Capital One Financial, Northern Trust, Ally Financial, American Express, Citizens Financial Group, Discover Financial Services, Fifth Third Bancorp, Huntington Bancshares, KeyCorp, M&T Bank, and Regions Financial).
Source: Firms' earnings releases for 2020:Q1 data. FR Y-9C for 2019:Q4 data.
Strains in funding markets have eased.
Strains in bank funding markets have eased somewhat from their stressed condition in March. Banks are increasingly able to access short-term funding markets at longer terms of six months and beyond, an improvement from late March when short-term markets were largely closed at maturities longer than one week. Banks issued substantial amounts of long-term debt throughout April. Large banks have generally remained above their liquidity coverage ratio and internal liquidity stress test requirements. While bank loans have grown sharply, deposits have grown just as rapidly, supporting banks' healthy liquidity positions.
Key market indicators highlight the extent of challenges posed by the current crisis.
Market-based indicators of bank health, such as the market leverage ratio and credit default swap (CDS) spreads, started to deteriorate in the latter half of February as investors began to price in the impact of the potential economic contraction. The market leverage ratio fell from mid-February into the latter half of March, before recovering somewhat.6 CDS spreads also deteriorated, climbing from mid-February through the first half of March, before falling back again somewhat (figure 7).7 Still, neither indicator reached the extremes of the 2008 financial crisis (figure 8). This may reflect the belief by investors that banks are more resilient and better positioned today than during the 2008 financial crisis.
Table 1. Summary of organizations supervised by the Federal Reserve (as of 2019:Q4)
| Portfolio | Definition | Number of institutions | Total assets ($ trillions) |
|---|---|---|---|
| Large Institution Supervision Coordinating Committee (LISCC) | Eight U.S. global systematically important banks (G-SIBs) and four foreign banking organizations | 12 * | 12.4 |
| State member banks (SMBs) | SMBs within LISCC organizations | 5 | 0.8 |
| Large and foreign banking organizations (LFBOs) | Non-LISCC U.S. firms with total assets $100 billion and greater and non-LISCC FBOs | 173 | 7.5 |
| Large banking organizations (LBOs) | Non-LISCC U.S. firms with total assets $100 billion and greater | 16 | 3.6 |
| Large FBOs | Non-LISCC FBOs with combined U.S. assets $50 billion and greater | 14 | 2.8 |
| Small FBOs | FBOs with combined U.S. assets less than $50 billion | 143 | 1.0 |
| State member banks | SMBs within LFBO organizations | 6 | 0.6 |
| Regional banking organizations (RBOs) | Total assets between $10 billion and $100 billion | 88 | 2.2 |
| State member banks | SMBs within RBO organizations | 41 | 0.7 |
| Community banking organizations (CBOs) | Total assets less than $10 billion | 3,815** | 2.4 |
| State member banks | SMBs within CBO organizations | 702 | 0.5 |
| Insurance and commercial savings and loan holding companies (SLHCs) | SLHCs primarily engaged in insurance or commercial activities | 8 insurance 4 commercial | 1.1 |
* In March 2020, the Federal Reserve announced that UBS will now be supervised as part of the LFBO portfolio. This change will be fully reflected in the next iteration of this report.
** Includes 3,754 holding companies and 61 state member banks that do not have holding companies.
Source: Call Report, FFIEC 002, FR 2320, FR Y-7Q, FR Y-9C, FR Y-9SP, and S&P Global Market Intelligence.
Figure 7. Average credit default swap (CDS) spread and market leverage ratio, 2020 (daily)
Note: The market leverage ratio is the ratio of market value of equity to market value of equity plus total liabilities. Averages are calculated from available observations for the eight U.S. and three FBO LISCC firms (U.S.: Bank of America, Bank of New York Mellon, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street, and Wells Fargo; FBO: Barclays, Credit Suisse, and Deutsche Bank) and UBS.
Source: Bloomberg.
Figure 8. Average credit default swap (CDS) spread and market leverage ratio, 2006 to 2020 (month-end)
Note: The market leverage ratio is the ratio of market value of equity to market value of equity plus total liabilities. Averages are calculated from available observations for the eight U.S. and three FBO LISCC firms (U.S.: Bank of America, Bank of New York Mellon, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street, and Wells Fargo; FBO: Barclays, Credit Suisse, and Deutsche Bank) and UBS.
Source: Bloomberg.
Box 1. Changes to the Discount Window
The Federal Reserve's program for lending to depository institutions (DIs), commonly known as the "discount window," plays an important role in supporting the liquidity and stability of the banking system. By providing ready access to funding, the discount window helps DIs manage their liquidity risks efficiently and avoid actions that have negative consequences for their customers, such as withdrawing credit during times of market stress.
In order to encourage DIs to use the discount window to meet demands for credit from households and businesses, the Federal Reserve announced on March 15 that it would lower the primary credit rate by 150 basis points to 25 basis points and allow DIs to borrow from the discount window for as long as 90 days.1 The Federal Reserve, the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC) supported these actions by issuing an interagency statement encouraging banks to use the discount window. A statement on March 19 outlined the notable increase in discount window borrowing that followed and expressed encouragement that banks were willing to use these borrowings as a source of funding.2 Bank borrowing from the discount window has increased substantially following the changes detailed above (figure A).3
Figure A. Total discount window borrowings (weekly average daily balance)
Source: H.4.1, "Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks."
1. Board of Governors of the Federal Reserve System, "Federal Reserve Actions to Support the Flow of Credit to Households and Businesses," news release, March 15, 2020, https://www.federalreserve.gov/newsevents/pressreleases/monetary20200315b.htm. Return to text
2. Board of Governors of the Federal Reserve System, "Federal Reserve Board Encouraged by Increase in Discount Window Borrowing to Support the Flow of Credit to Households and Businesses," news release, March 19, 2020, https://www.federalreserve.gov/newsevents/pressreleases/monetary20200319c.htm. Return to text
3. See H.4.1 releases, "Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks" at https://www.federalreserve.gov/releases/h41/. Return to text
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References
2. The population for most data used in the Banking System Conditions section includes both banks and bank holding companies. See the data appendix for descriptions of data panels. Return to text
3. See, e.g., Financial Stability Board (FSB), "FSB Members Take Action to Ensure Continuity of Critical Financial Services Functions," news release, April 2, 2020, https://www.fsb.org/2020/04/fsb-members-take-action-to-ensure-continuity-of-critical-financial-services-functions/. Return to text
4. Loan loss provision is an expense item in the income statement to cover potential loan losses. Return to text
5. CECL requires firms to account for future expected losses, as opposed to the previous incurred loss methodology, which required provisioning only when losses materialized. Return to text
6. The market leverage ratio is a market-based measure of a bank's capital position, where a higher ratio indicates greater investor confidence in the financial strength of the bank. Return to text
7. CDS spreads are a measure of market perceptions of bank risk, where small spreads reflect higher investor confidence in the financial health of banks. Return to text