Banking system financially sound, though credit risk rising, Fed report finds

The banking system remains financially sound in the face of a changing economy, the Federal Reserve said Thursday, but it also noted that credit risk has increased as exhibited by increased credit loss provisions by banks expecting future loan deterioration.

According to the Fed’s latest Supervision and Regulation Report, published twice a year, banks’ financial conditions in the first half of 2022 remained sound as almost all reported capital above regulatory minimums. The agency said although was liquidity was reduced, it generally remained ample; loan delinquencies were historically low, the Fed added.

However, uncertainty in the economy – particularly with rising inflation – caused firms to act, increasing credit loss provisions during the first half of 2022 taking steps to prepare for the possibility of weaker economic conditions.

Nevertheless, the report indicated, banks posted solid supervisory numbers in the year’s firsth three quarters, but with exceptions particularly among very large institutions. “Most firms maintained satisfactory supervisory ratings, and the number of unresolved supervisory findings has been declining; however, some findings are taking longer than expected to remediate, especially for global systemically important banks (G-SIBs) and other large banks,” the Fed said. “In response, supervisory priorities are focused on firms’ remediation of previously identified supervisory findings and risks emerging from changing economic conditions.”

Other findings of the report included:

  • Loan balances continued to increase in the first three quarters of the year across all major loan categories.
  • Bank financial performance remained stable, although average return on assets fell from the first half of 2021.
  • Banks reported low delinquency and net charge-off rates in major loan categories.
  • Although capital and liquidity positions were “adequate,” securities depreciation “is significant” at some banks.
  • Bank market indicators have weakened since the start of 2022. “The average market leverage ratio and average credit default swap (CDS) spread for firms supervised by the Large Institution Supervision Coordinating Committee (LISCC) program deteriorated in the first half of 2022 amid increased uncertainty related to the Russian invasion of Ukraine and as market participants reassessed the potential for an economic slowdown,” the report stated. “Both indicators recovered slightly at the start of the third quarter. However, between mid-August and mid-October, the average market leverage ratio has fallen and the average CDS spread has increased.”

Federal Reserve Supervision and Regulation Report, November ‘22