The Federal Reserve’s recent Supervision and Regulation Report, released today, has described the U.S. banking system as fundamentally sound and resilient, even in the face of March’s acute stress events. The report highlighted that banks have successfully maintained capital and liquidity ratios well above regulatory minimums while managing to keep earnings performance consistent with pre-pandemic levels, despite challenges such as pressure on net interest margins.
The failures of Silicon Valley Bank, Signature Bank (OTC: SBNY), and First Republic Bank (OTC: FRCB) were acknowledged in the report. These were primarily attributed to their excessive interest rate risk from long-duration assets and heavy reliance on uninsured deposits. As interest rates have risen, other banks with similar investments in fixed-rate, long-duration assets when rates were lower have seen significant declines in asset values.
In response to a slowdown in lending growth due to reduced demand and tighter lending standards, banks have increased provisions for credit losses. This is especially pertinent given the uptick in delinquencies related to commercial real estate and certain consumer sectors. However, loan delinquency rates remain low on the whole.
The Federal Reserve has taken steps to strengthen bank supervision in light of these issues and the bank failures earlier this year. A novel supervision program has been implemented to enhance oversight, particularly for banks involved in nontraditional financial-technology-related activities.
Reflecting on the measures taken since the Global Financial Crisis, the report notes that capital ratios for the largest banks have doubled since 2009 due to a series of reforms aimed at bolstering the quantity and quality of bank capital. These reforms include annual supervisory stress tests and a capital surcharge for globally systemically important banks (G-SIBs).
Furthermore, in July, the Federal Reserve Board proposed new rules alongside the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) to decrease future financial crisis risks. The proposed regulations would apply to banks with assets of $100 billion or more and would replace banks’ internal credit risk estimates with a standardized measure.
The agencies have also finalized a rule that updates regulations under the Community Reinvestment Act (CRA), aiming to better motivate banks to serve the needs of their entire communities, including low- and moderate-income areas.
This report comes after last week’s Liberty Street Economics blog post by the New York Fed that pointed out vulnerabilities in the banking sector due to abrupt interest rate hikes. While banks can benefit from gradual increases, immediate losses in securities portfolios could lead to funding shortages and reduced capital levels. Yet, despite these risks, the Capital Vulnerability Index remains historically low at 1.55% of GDP.
The Federal Reserve’s October Senior Loan Officer Opinion Survey (SLOOS) further detailed a tightening of lending standards and a dip in demand, which is largely attributed to an uncertain economic outlook and various concerns over loan quality and funding costs.
Together, these insights from different Federal Reserve sources provide a comprehensive view of the current state of U.S. banking amid an environment characterized by rising interest rates and economic uncertainty.
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