Banking System Conditions
The banking system remains sound overall. Banking organizations continue to report capital and liquidity levels above regulatory minimums. Earnings performance has remained solid and in line with pre-pandemic levels, despite recent pressure on net interest margins. Deposit declines related to the March banking stresses have slowed. Loan delinquency rates remain low overall. However, delinquencies for CRE and some consumer sectors have increased from their low levels, and banks have increased credit loss provisions. Liquidity and interest rate risks also remain elevated for some banks, partially attributed to the increased funding costs and significant fair value losses on investment securities.
Banking Firms Increased Regulatory Capital, but Tangible Capital Remains Depressed
Regulatory capital ratios increased during the first half of 2023. The industry's aggregate common equity tier 1 (CET1) capital ratio rose to 12.5 percent as of June 30, 2023, a fourth consecutive quarterly increase (figure 1). This reflects over $2 trillion in CET1 capital across the banking system.
Figure 1. Aggregate common equity tier 1 (CET1) capital ratio
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Note: CET1 capital ratio is the ratio of common equity tier 1 capital to risk-weighted assets. See appendix A for further information. Community banks can opt into the community bank leverage ratio framework. Thirty-seven percent of community banks have done so and are excluded from the figure.
Source: Call Report and FR Y-9C.
However, tangible capital levels, which include declines in the fair values of securities but exclude intangible assets such as goodwill, remained under pressure for many banks. As of the second quarter of 2023, banks' balance sheets reflected declines in fair value of $248 billion in available-for-sale securities, which are reflected in tangible capital. In addition, banks reported more than $310 billion in declines in the fair value of held-to-maturity securities.
Accounting standards do not require banks to reflect declines in the fair value of held-to-maturity securities within equity capital.1 However, substantial declines in the fair value of securities are still a concern for banks facing liquidity constraints, which could force some of these banks to sell securities at a loss.
Liquidity Risks Persist for Some Banks
Liquidity levels have come down from their peak in 2021 but remain above pre-pandemic levels. Firms reported a slight drop in liquid assets in the first half of 2023, as a decline in investment securities was partially offset by an increase in cash balances over this period (figure 2).
Figure 2. Liquid assets as a share of total assets
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Note: Liquid assets are cash plus estimates of securities that qualify as high-quality liquid assets, as defined by the Basel III liquidity coverage ratio requirement.
Source: FR Y-9C.
After reaching a historic high of $18 trillion in April 2022, deposits declined steadily through February 2023 as interest rates increased and some depositors sought higher returns in non-deposit investments. Deposit declines accelerated during the first half of 2023 following the failures of three large U.S. banks. Deposits at commercial banks fell by nearly $400 billion from the start of March through April (figure 3), with most of the decline concentrated in March. Between May and the end of August, deposit levels stayed largely stable.
Figure 3. Deposits
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Note: Data are for all commercial banks and are seasonally adjusted.
Source: H.8, "Assets and Liabilities of Commercial Banks in the United States."
As deposit levels have declined, banks have increased their use of wholesale funding sources from historic lows seen in early 2022 (figure 4).2
Figure 4. Wholesale funding as a share of total assets
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Note: Wholesale funding is defined as the sum of brokered deposits under $250,000, federal funds purchased, securities sold under agreements to repurchase, subordinated notes, and other borrowed money.
Source: Call Report and FR Y-9C.
Loan Growth Slowed and Delinquencies Increased for Some Sectors
The pace of loan growth has slowed relative to 2022. Total loan balances grew just 0.7 percent in the first half of 2023, compared with 3.8 percent in the first half of 2022. According to respondents to recent Federal Reserve Senior Loan Officer Opinion Surveys, both reduced loan demand and tighter lending standards contributed to a lending slowdown.3
Loan delinquency rates remain low. However, delinquency rates for CRE and consumer loans increased slightly during the first half of 2023 (figure 5). For the largest firms, the CRE office loan segment showed the largest increase in delinquency rates (figure 6).
Figure 5. Loan delinquency rates
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Note: Delinquent loans are those 90+ days past due or in nonaccrual status.
Source: Call Report and FR Y-9C.
Figure 6. Income-producing CRE loan delinquency rates by property type
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Note: Delinquent loans are those 30+ days past due or in nonaccrual status.
Source: FR Y-14Q.
Within the consumer loan segment, credit card loan delinquencies have increased post-pandemic. After falling to near-record lows in the second half of 2021, credit card delinquency rates rose over the second half of 2022. The overall credit card delinquency rate reached 1.4 percent in the second quarter of 2023, roughly in line with pre-pandemic levels (figure 7). The increase in credit card delinquencies was concentrated among subprime and near-prime borrowers, whose delinquency rates have slightly exceeded pre-pandemic levels in 2023.4
Figure 7. Consumer loan delinquency rates
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Note: Delinquent loans are those 90+ days past due or in nonaccrual status.
Source: Call Report and FR Y-9C.
Higher Interest Expense and Rising Provisions Moderated Earnings
Bank earnings performance during the first half of 2023 remained sound. Return on average assets and return on equity remained above their 10-year averages (figure 8). Higher noninterest income helped offset lower net interest income and increased provisions. The industry's noninterest income included nonrecurring gains related to the acquisitions of three large, failed banks, adding about 16.2 percent and 4.0 percent to bank earnings in the first and second quarter, respectively.5 Even after excluding these gains, earnings were comparable with pre-pandemic levels.
Figure 8. Bank return on average assets (ROAA) and return on equity (ROE)
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Note: ROE is net income divided by average equity capital, and ROAA is net income divided by average assets. The dip in ROE and ROAA in the fourth quarter of 2017 was driven by a one-time tax effect associated with the Tax Cuts and Jobs Act of 2017.
Source: Call Report and FR Y-9C.
Net interest margins measure the difference between interest income and the amount of interest paid for funding, expressed as a share of average earning assets. These margins declined from 3.4 percent in the fourth quarter of 2022 to 3.2 percent in the second quarter of 2023 as increased rates paid on deposits and wholesale funding were not fully offset by growth in interest income (figure 9).
Figure 9. Net interest margin
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Note: Net interest margin is net interest income divided by average interest-earning assets, annualized. Net interest income is interest income minus interest expense.
Source: Call Report and FR Y-9C.
In the second quarter of 2023, many U.S. banks also increased provisions for credit losses. Provisions increased from an annual rate of 0.65 percent of average loans and leases in the first quarter of 2023 to an annual rate of 0.73 percent of average loans and leases in the second quarter of 2023.
Bank Market Indicators Show Mixed Signals
Market assessments of bank risk, including the market leverage ratio and credit default swap (CDS) spreads, provide a forward-looking assessment of the strength of the banking system. The market leverage ratio is a measure of a firm's financial position that considers the relationship between a firm's market capitalization and its liabilities. Lower stock prices reduce the ratio of a firm's market capitalization to its debt, which indicates less market confidence in a firm's financial strength. Conversely, higher stock prices produce a higher ratio, reflecting a higher degree of confidence in a firm's financial strength. As a complement to market leverage, CDS spreads track the price of insurance against a default by a given firm. If a firm's CDS spread rises, it means the market has lower confidence in a firm's creditworthiness. Lower CDS spreads indicate higher confidence in a firm's creditworthiness, according to the market.6
During 2023, the average market leverage ratio for the largest banks has declined, remaining lower than levels seen at the beginning of the year. The average CDS spread for the largest banks also worsened between the start of March and early May. The average CDS spread has since fallen below its levels at the start of the year, though it is still elevated relative to pre-pandemic levels (figure 10).
Figure 10. Average credit default swap (CDS) spread and market leverage ratio (daily)
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Note: The market leverage ratio is the ratio of a firm's market capitalization to the sum of market capitalization and the book value of liabilities. Averages are calculated from available observations for the eight LISCC firms (Bank of America Corporation, The Bank of New York Mellon Corporation, Citigroup Inc., The Goldman Sachs Group, JPMorgan Chase & Co., Morgan Stanley, State Street Corporation, and Wells Fargo & Company).
Source: Federal Reserve staff calculations using Bloomberg data.
Credit rating downgrades from Moody's and S&P Global in August contributed to pressure on some bank stock prices. These two credit agencies downgraded credit ratings or lowered outlooks for more than 20 banks, affecting all but the largest tier of banks. Both Moody's and S&P Global referenced the higher interest rate environment and CRE exposure as considerations in the downgrades.
Third-Quarter 2023 Earnings at Large Firms
This section provides a recap of banking sector conditions for the third quarter of 2023, based on earnings results for 22 large U.S. bank holding companies and one large savings and loan holding company.7 While such trends are indicative, it should be noted that the sample may not necessarily be representative of the banking sector.
In the third quarter of 2023, aggregate large bank profitability, as measured by return on equity, approximated 12 percent, roughly the same level as reported in the second quarter of 2023. As compared with the second quarter, large banks reported lower net interest income, which was offset by higher capital markets fees and a smaller credit loss provision.
Large banks generally reported that deposit costs continued to rise but at a slower pace than experienced in each of the first two quarters in 2023. Most also reported that deposit balances were stable during the third quarter of 2023.
Large banks modestly built credit loss allowances during the third quarter of 2023, and loan growth was muted. Loan loss rates were largely unchanged quarter-over-quarter but were higher than those experienced in the third quarter of 2022.
The aggregate CET1 capital ratio for large banks approximated 12 percent on September 30, 2023, which was higher than the level seen at June 30, 2023, and at the end of 2022. Higher CET1 capital ratio levels reflect targeted efforts by bank management teams to build CET1 capital and control risk-weighted-asset growth.
References
1. For held-to-maturity securities that were transferred from the available-for-sale category, declines in fair value that existed at the date of the transfer are reported within equity capital. Return to text
2. Wholesale funding levels are now in line with their 10-year average. Return to text
3. Board of Governors of the Federal Reserve System, "The April 2023 Senior Loan Officer Opinion Survey on Bank Lending Practices" (Washington: Board of Governors, 2023), https://www.federalreserve.gov/data/sloos/sloos-202304.htm; and "The July 2023 Senior Loan Officer Opinion Survey on Bank Lending Practices" (Washington: Board of Governors, 2023), https://www.federalreserve.gov/data/sloos/sloos-202307.htm. Return to text
4. Andrew Haughwout, Donghoon Lee, Daniel Mangrum, Joelle Scally, and Wilbert van der Klaauw, "Credit Card Markets Head Back to Normal after Pandemic Pause," Liberty Street Economics blog, Federal Reserve Bank of New York, August 8, 2023, https://libertystreeteconomics.newyorkfed.org/2023/08/credit-card-markets-head-back-to-normal-after-pandemic-pause/. Return to text
5. Nonrecurring gains on the acquisitions of failed banks contributed to higher noninterest income at certain large banking organizations. Return to text
6. See appendix A for additional information on market indicators. Return to text
7. The sample includes Ally Financial Inc.; American Express Company; Bank of America Corporation; The Bank of New York Mellon Corporation; Capital One Financial Corporation; The Charles Schwab Corporation; Citigroup Inc.; Citizens Financial Group, Inc.; Discover Financial Services; Fifth Third Bancorp; The Goldman Sachs Group, Inc.; Huntington Bancshares Incorporated; JPMorgan Chase & Co.; KeyCorp; M&T Bank Corporation; Morgan Stanley; Northern Trust Corporation; The PNC Financial Services Group, Inc.; Regions Financial Corporation; State Street Corporation; Truist Financial Corporation; U.S. Bancorp; and Wells Fargo & Company. Data are unadjusted for mergers and acquisitions. Return to text