WASHINGTON — Key indicators of the banking industry’s health fell to their lowest levels in more than a year during the first quarter, signaling trouble on the horizon, especially for smaller institutions.
The Federal Reserve Board of Governor’s
Overall loan delinquency also fell below 1 percent, the lowest rate since 2006.
Yet, the report also highlighted some emerging red flags. It noted that the aggregate market leverage ratio — which measures confidence in banks’ capital positions — fell to its lowest level since February 2021. Meanwhile, spreads on credit default swaps crept up to their highest level since spring 2020.
The Fed credits uncertainties raised by ongoing Russian invasion of Ukraine for the deterioration of market confidence. While U.S. banks have little direct exposure to the countries, the conflict has impacted commodity prices and created volatility in numerous consumer-facing industries. Banks are also on higher alert for cyber security threats that could come as retaliation for U.S. sanctions against Russia.
Bank profitability was already waning before Russian troops advanced on Ukraine in late February, the Fed’s report shows. Returns on average assets and equity, the two metrics used to gauge profitability, declined in each of the final three quarters of 2021. (First-quarter results from this year were not included in the report.) The Fed attributes this slide to increased loan losses and lower trading volume for large banks, though it notes that such institutions project higher margins this year as interest rates on bank assets increase.
Community and regional banks, those with less than $10 billion and between $10 billion and $100 billion of assets, respectively, face the greatest risks, the report noted. While most of these organizations remain well capitalized, their books also tend to have a higher concentration of commercial real estate loans, many of which have struggled to perform during the pandemic. Operationally, smaller banks are also less equipped to deal with cyber threats than their larger counterparts, the report notes.
Cybersecurity will be a top priority for the Fed this year, according to the report. Supervisors will take keen interest in the controls banks have in place to manage access to their systems and information. They will also focus on how banks identify and respond to ransomware attacks.
After the
Researchers for Cowen Inc., a New York-based investment company, said the Fed’s overall findings paint a favorable picture of the banking sector. However, based on the red flags noted in the report, the firm expects the Fed to step up its capital requirements for banks in the near future and take a more skeptical approach to bank mergers and acquisitions.
“Despite our positive assessment of the report, we still expect Democrats on the Federal Reserve Board to toughen the [Comprehensive Capital Analysis and Review] stress test in ways that will effectively raise large bank capital requirements by another 100 to 200 basis points,” the firm said in a statement. “We also do not see the report as improving the bank M&A environment as the regulatory focus there is less about the current health of banks and more about how to oversee increasingly large institutions.”
