As shown in Exhibit 1, The Clearing House Bank Conditions Index (TCHBCI) in the first quarter of 2017 had the highest level of resiliency since the start of the index in the first quarter of 1996. The index provides a quantitative assessment of the resiliency of the U.S. banking sector and is constructed using a wide range of common indicators of bank condition. The aggregate index and all of the subindexes take values between 0 and 100 to allow for a straightforward comparison of each category over time. A value of the index close to 100 corresponds to a banking sector that is the least vulnerable it has ever been since the first quarter of 1996, the first available data point of the index. In contrast, a value close to 0 implies that the U.S. banking sector is as vulnerable as it has ever been over that interval.
As shown in Exhibit 2, the increase in resiliency in TCHBCI relative to the fourth quarter of last year was widespread across all categories of the index. Specifically, the categories that experienced the most notable increases were risk aversion, profitability, interconnectedness, and asset quality. The increase in the level of banks’ risk aversion is in most part driven by the decline in the ratio of loans to GDP. In particular, the pace of growth in loans and leases slowed markedly, from 2.7% in the fourth quarter of last year to -0.3% in the first quarter of 2017. The decline in loans and leases on banks’ books in the first quarter is likely attributable to the recent increase in both short-term and long-term interest rates. On the business side, in response to the rise of short-term rates and the expectation that the Federal Reserve will increase short-term interest rates further this year, corporations turned to the bond market to secure funding at what are still relatively low interest rates, and have used some of those proceeds to pay down some of their outstanding C&I loans. On the residential real estate side, higher longer-term interest rates also caused a noticeable decline in mortgage refinancing applications. That said, regulatory headwinds arising from tighter banking regulations have likely continued to put downward pressure on loan growth.
The other categories of the index also shifted toward levels consistent with greater bank resilience. Banks recover from adverse shocks primarily by rebuilding capital through retained earnings, so a more profitable banking system is more resilient. Although bank profitability is still low by historical standards, it rose in the first quarter of 2017, mainly because of a rise of non-interest income as net interest margins were about unchanged. Moreover, bank interconnectedness continued to decline (consistent with an increase in resilience) due importantly to a reduction in the conditional value at risk, or CoVaR, a market-based measure of systemic risk that we added to the index this quarter as an additional measure of interconnectedness. The CoVaR estimates the losses the financial system would incur if one of the U.S. globally systemically important banks were to be in distress. On the asset quality side, all the subcomponents improved over the quarter with the exception of net charge-offs, which were about unchanged. Among the remaining categories of the index, capital and liquidity rose further, driven by increases in risk-based regulatory capital ratios and holdings of high-quality liquid assets, respectively. On the liquidity side, although the gap between the maturity of assets and liabilities continued to rise, banks’ dependence on short-term wholesale funding remains at very low levels.
Finally, Exhibit 3 provides the readings on each of the six categories that make up TCHBCI at two different points in time: (i) the end of 2008, the nadir of the past crisis, and (ii) the most recent quarter. Points plotted near the center of the chart indicate a high degree of vulnerability in that category while points plotted near the rim indicate high resiliency. As shown by the red line, in the fourth quarter of 2008 (the quarter immediately after the failure of Lehman Brothers), almost all categories of the aggregate index were at very low levels, indicating the presence of acute vulnerabilities. Over the years since the crisis, almost all categories of the index have improved considerably, as shown by the blue line, especially the capital and liquidity positions of U.S. banks. These improvements largely reflect the efforts of commercial banks to increase their capital and liquidity following the financial crisis, the more stringent capital and liquidity requirements that are part of Basel III, and the U.S. stress tests.
