The Bank Conditions Index (BCI), which provides a summary measure of the condition of the U.S. banking system, shows an extremely resilient system, reflecting in large part the very strong capital and liquidity positions of banks as well as a prudent stance on loan originations.
The index rose in the third quarter of 2018, as shown in Exhibit 1. Over the last two quarters improvements in the BCI were widespread across almost all categories of the index. Specifically, in the third quarter the increase in resilience in the BCI was driven by improvements in profitability, liquidity, and asset quality. Overall, the BCI remains well above the level that maximizes the contribution of the index in tracking future GDP growth, suggesting that risk aversion by banks or banking regulations continue to be holding back economic growth somewhat.
Exhibit 2 depicts the heat map of the BCI for each of the six categories that make up the aggregate index. Values near 100 (higher resiliency) are shown in blue; values near 0 (higher vulnerability) are shown in red. The capital, liquidity, and risk aversion categories exhibit very high levels of resiliency in the third quarter of 2018, in part because of the post-crisis regulatory reforms. The remaining three components – asset quality, interconnectedness, and profitability – show levels of resiliency that are close to historical standards. In addition, five of the six subcomponents of the BCI – capital, liquidity, asset quality, interconnectedness, and profitability – became more resilient in the third quarter of 2018. Of those, the liquidity, asset quality, and profitability categories showed significant improvements in their degree of resiliency. Only the risk aversion category experienced a decline in the degree of resiliency this quarter.
The increase in the resiliency observed in the liquidity category was driven by an increase in BPI’s proxy for the net stable funding ratio (NSFR) and a decrease in the maturity mismatch between assets and liabilities. The share of liabilities financed by short-term wholesale funding was about unchanged. The NSFR is a measure of bank liquidity over a one-year horizon, and it is defined as the ratio of a bank’s available stable funding to its required stable funding. The former includes the sum of weighted capital and liabilities, while the latter is made up of assets that have different weights meant to measure the illiquidity of the assets. The increase in the estimated NSFR in the third quarter of 2018 was driven by a decrease in the amount of required stable funding. Overall, U.S. banks continued to have highly liquid balance sheets and sizable liquidity buffers, and banks’ share of high-quality liquid assets remained very elevated.
Bank profitability continues to recover, as measured by improvements in banks’ return on assets and return on equity, which are now close to historical standards. Net interest margins and noninterest income edged up as well. These components of the profitability category have increased steadily since the first quarter of 2018. The improvement in the asset quality category was also widespread across all series of the index, including a decline in the ratio of nonperforming loans to loans and an increase in the ratio of loan loss reserves to nonperforming loans. The recent reports on rising delinquency rates on consumer loans are driven by a deterioration of loans held by non-banks. The delinquency rate on consumer loans held by banks was about unchanged in the third quarter.
The capital and interconnectedness categories rose slightly in the third quarter. Under the capital category, the market leverage ratio under stress rose, while regulatory capital ratios remained roughly unchanged. The slight rise in resiliency in the interconnectedness category was driven by a decrease in exposures to financial entities, defined as the ratio of loans made to other depository institutions, repos, and federal funds sold to total assets.
Lastly, the risk aversion category fell in the third quarter, driven by an easing in lending standards, a rise in average risk-weights, and a modest increase in ratio of loans to deposits. This was partly offset by a decline in the loan-to-GDP gap. Currently, the gap is well below its long-run trend and declined further in the third quarter, signaling a lackluster growth rate of loans relative to the size of the economy. The softness in bank lending is in part due to competition from the non-bank sector, and based on the loan-to-GDP gap, it would be a bad idea to raise the countercyclical capital buffer. In addition, headwinds arising from tighter banking regulations have likely continued to put downward pressure on loan growth, particularly on loans to small businesses and loans to borrowers with less-than-pristine credit histories.1
ENDNOTE
1 “Bank Regulations as a Tax on Lending” https://bpi.com/bank-regulations-as-a-tax-on-lending/
