Banks’ Stable Post Crisis

Banks have been going through a tumultuous period. While there are echoes of the Great Financial Crisis of 2007-2009, so far banks have faced a liquidity issue and not a profitability one like before.

At the onset of the liquidity crisis in early March, banks made significant adjustments to their balance sheets to bolster reserves. However, as March ended, these adjustments ceased, and banks resumed normal operations, with deposits steadying to pre-crisis declines. Furthermore, this crisis primarily targeted regional banks versus larger diversified banks. However, when we separate our analysis between small and large banks, their actions show a minimal difference, likely because a significant percentage of regional banks are classified as large banks, i.e., the top twenty-five by asset size.

Our analysis compares the 5-week average growth in the week before the liquidity crisis with the week after. Minor differences occur in the pre- and post-period, and any variation is well within the norms of the past year. It suggests that when the dust settled, banks did not significantly change their lending behavior in response to the crisis. Auto loans and Commercial & Industrial (C&I) loans had been flat to declining prior to the crisis and remained that way after. Residential real estate mortgages appear entirely unaffected and continue to grow. Reserves increased due to sales of security holdings and additional borrowing from the Federal Reserve.

Relatively unchanged lending activity on banks’ balance sheets lines up with the Senior Loan Officer Survey. Results of the Senior Loan Officer Survey reveal that while there continues to be a tightening in lending standards, the growth rate appears to be slowing, meaning banks have already significantly tightened prior to the crisis. The net percentage of respondents tightening standards for C&I loans increased from near zero in 2Q2022 to forty in 4Q2022 and only jumped another six percentage points in the first half of 2023.

Officially, the Great Financial Crisis began in 2007, but as early as 2Q2005, the share of banks with year-over-year earnings growth began to decline steadily. In 3Q2006, the share of unprofitable banks also began to tick up, and in 4Q2006 reached a level not seen since 4Q2001 when the economy was barely out of a recession.

Current trends do not resemble the past at all. The share of unprofitable banks in 4Q2022 (5.7%) is below that of a year ago (8.1%). Furthermore, the share of banks with year-over-year earnings growth increased to 70% in 4Q2022 from 52% in 4Q2021.?

For now, this is very much a liquidity problem isolated to a handful of banks, and signs of a profitability crisis are limited. However, heavy defaults in the commercial real estate sector can turn this into a profitability crisis.