The Federal Reserve releases a semiannual report on the supervision and regulation of the current banking environment. The report is published by the Federal Reserve Board and is intended to inform the public and provide transparency about its supervisory and regulatory policies and actions, as well as the current banking conditions. The report focuses on three main points. The banking system conditions, regulatory developments, and supervisory developments. Here we will focus on the current banking conditions as it is the most important for the average investor to understand and to become intimately familiar with.
The Federal Reserve tells us that the banking system remains overall strong with some uncertainty due to the current geopolitical tensions, namely Russia’s invasion of Ukraine and the ripple effect this war has had on the entire world. They go on to back up their claims that the banking system remains strong. I have analyzed their claims and provided the essential information needed to help you seamlessly understand their claims as well.
Firstly, capital and liquidity positions are robust. This allows the banks to continue supporting the economy as well as preparing it for potential adverse market events. In the second half of 2021 asset quality improved and bank profitability remained strong and loan growth increased. Banks have been reporting high levels of capital and liquidity through the economic turmoil of the bear market begins. Since the COVID pandemic industry has added $230B in additional common equity tier one capital, the core capital that banks hold. This increase in capital allows banks to maintain and/or increase their lending as well as buffers them from any losses that may accrue in a down trending market. The aggregate common equity tier one capital ratio was 12.65% at the end of 2021, which is slightly above the five year average (see Figure 1). Banks also finished 2021 with ample liquidity. Their cash and securities made up 28% of their total assets (see Figure 2). Strong deposit growth supported this increase in liquid assets and allowed for the banks to reduce their reliance on more volatile investments.
Banks also reported lower delinquency rates in most loan categories. On top of this many market indicators that assess the quality of the banking system also improved in the second half of 2021. Of those the most important is aggregate loan delinquency. The aggregate loan delinquency rate fell below 1% and now rests at is lowest rate since late 2006 (see Figure 3). There is one exception to this, consumer loans. Consumer loans saw a slight increase in late 2021. This discrepancy is thought to have been caused by an increase in late car loan payments. Modified loan balances continue to decline as government pandemic programs are coming to a close. Loans modified in accordance with section 4013 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act fell for the 6th consecutive quarter to less than 25% of its peak (see Figure 4).
After stabilizing in 2021 the market leverage ratio and credit default swap spreads have both dropped during the first quarter of 2022, mainly due to the Russian invasion of Ukraine. In March 2022 the market leverage ratio dropped to just 9%, the lowest since February 2021 (see Figure 5). Bank profitability declined in the last 3 quarters of 2021 and are just now recovered to pre-pandemic levels. In the first quarter of 2022 loan balances continued to grow, but with a slowed pace relative to the fourth quarter of 2021.
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