The Clearing House Bank Conditions Index (TCHBCI) declined slightly in the fourth quarter of 2017 but continues to show an extremely resilient banking system, reflecting in large part the very strong capital and liquidity positions of U.S. banks (Exhibit 1). Last quarter, the increase in the level of resiliency was evenly distributed across subcomponents, and the index remained close to the highest possible level of resiliency. This quarter, however, there was a slight decline, due partially to the continued widening of the maturity gap and banks’ response to U.S. tax reform. Overall, the changes in each of the six subcomponents of the index – capital, liquidity, risk aversion, asset quality, interconnectedness, and profitability – were mixed in the fourth quarter. The capital and liquidity categories of the index experienced small declines but remained close to their highest level of resiliency. The index also showed a modest decrease in risk aversion by banks, and profitability remained subdued. In contrast, the asset quality and interconnectedness categories continued to show improvements in the degree of resiliency.
Exhibit 2 depicts the heat map of TCHBCI and for each of the six categories that comprise the aggregate index. Values near 100 (higher resiliency) are shown in blue; values near 0 (higher vulnerability) are shown in red.
The slight decrease in the capital category was driven by U.S. tax reform – specifically, the reduction of the value of deferred tax assets as a result of the lower corporate tax rate and the repatriation of overseas earnings. Despite the decrease in regulatory capital ratios due to tax code changes, V-Lab’s measure of market leverage ratio under stress remained very close to the highest value reached in the post-crisis period.
The slight decline in resiliency observed in the liquidity category was driven by a continued increase in the gap between the maturity of assets and liabilities held by banks. In addition, the share of assets financed with short-term wholesale liabilities rose slightly, albeit from the very low post-crisis levels. U.S. banks continued to have highly liquid balance sheets and sizable liquidity buffers.
The decline in risk aversion was mainly driven by a slight easing of lending standards in the most recent Senior Loan Officer Opinion Survey. The ratio of loans to GDP and the loan to deposit ratio remained about unchanged. Headwinds arising from tighter banking regulations have likely also continued to put downward pressure on loan growth, particularly on loans to borrowers with less-than-perfect or insufficient credit histories. In particular, annual loan growth slowed from 7¼ percent in 2016 to 3½ percent in 2017. Bank profitability remained still somewhat subdued relative to historical standards, in which improvements in net interest margins were offset by relatively weak trading revenue.
All subcomponents under asset quality, namely net charge-offs, non-performing loans ratio, reserve to loans and reserves to non-performing loans ratio continued to improve. Recently, some reports have pointed to higher net charge-off rates on credit card loans at smaller banks, however such rise is quite modest and not noticeable in the aggregate data.
Finally, Exhibit 3 provides the readings on each of the six categories that comprise TCHBCI at two different points in time: (i) the end of 2008, the nadir of the past crisis, and (ii) the fourth quarter of 2017. Points plotted near the center of the chart indicate a high degree of vulnerability in that category; 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 banks to increase their capital and liquidity, the more stringent capital and liquidity requirements that are part of Basel III, living wills, improved risk management and the U.S. stress tests.
