Developments Affecting the Profitability of Commercial Banks

By Duca, John V.; McLaughlin, Mary M. | Federal Reserve Bulletin, July 1990 | Go to article overview
Save to active project

Developments Affecting the Profitability of Commercial Banks

Duca, John V., McLaughlin, Mary M., Federal Reserve Bulletin

Developments Affecting the Profitability of Commercial Banks In 1989, the profitability of U.S.-chartered insured commercial banks declined after having rebounded in 1988. In recent years, variations in loss provisioning have accounted for variations in profits; abstracting loss provisions, net income has been quite stable as a share of assets. Last year, another surge in loan loss provisions, concentrated at large banks with substantial loans to developing countries, pulled down the industry's return on assets to 0.51 percent, the second lowest level since 1970 (chart 1), and its return on equity to 7.94 percent. Despite the decline in profitability, dividends paid as a share of assets continued at high levels, reducing retained earnings to very low levels. In the aggregate, the primary capital ratio of banks decreased, but most of the decline was at money center banks, which dipped into capital to pay dividends. Banks increased loss provisions more than net charge-offs and ended the year with somewhat higher loan loss reserves (chart 2).

After peaking early in 1989, short-term interest rates declined from the spring through the end of the year as the Federal Reserve took steps to sustain economic growth (chart 3). Nevertheless, by the end of 1989, short-term market rates were still well above their 1988 averages. Reflecting the higher average level of rates, interest expense as a share of assets rose about 1 percentage point. Increases in delinquent loans restrained the pickup in the rate of return on banks' loan portfolios stemming from higher market rates. As a result, the spread between interest income and interest expense (net interest margin) narrowed slightly, although it remained above the average of recent years (table 1).

On a year-end basis, overall growth of interest-earning assets at U.S. banks picked up to a moderate rate, reflecting mainly stronger expansion of bank holdings of securities (table 2). Bank loan growth was near the pace of 1988 as reduced runoffs in foreign loans and a turnaround in security loans roughly offset a moderation of growth in consumer loans and domestic commercial and industrial (C&I) loans. Much of the slowing in business loans to domestic addressees occurred in lending that was unrelated to mergers. Growth in consumer loans held by banks was reduced by the issuance of securities backed by consumer loan receivables, a transaction that removes loans from bank balance sheets. By contrast, holdings of U.S. government securities, especially of mortgage-backed securities issued by government-sponsored agencies, picked up. This strength was particularly pronounced late in the year, when loan growth slowed and deposit inflows surged as households shifted funds out of thrift institutions and thrift institutions sold off mortgage assets.

Events in the thrift industry enabled commercial banks in 1989 to rely more on retail deposits for funding relative to managed liabilities, such as large time deposits. Banks gained retail deposits directly from thrift institutions by purchasing the deposits in several resolutions of failed institutions. In another and likely more important development, many households shifted or diverted their deposits from savings and loan associations into bank accounts in response to concerns about the viability of thrift institutions or in response to declines in very high deposit rates offered by troubled institutions.

A record 204 federally insured commercial banks failed last year, up slightly from 1988. As in recent years, the majority of the nation's failed banks were located in the Southwest, where banks continued to post high real estate losses. However, the number of banks classified by the Federal Deposit Insurance Corporation as being in danger of becoming insolvent fell sharply last year.


Changes in the balance sheet of the banking industry during 1989 largely reflected responses of banks to impending capital requirements, problems in loan quality, and circumstances in the thrift industry.

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
Loading One moment ...
Project items
Cite this article

Cited article

Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

Cited article

Developments Affecting the Profitability of Commercial Banks


Text size Smaller Larger
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

While we understand printed pages are helpful to our users, this limitation is necessary to help protect our publishers' copyrighted material and prevent its unlawful distribution. We are sorry for any inconvenience.
Full screen

matching results for page

Cited passage

Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.

Are you sure you want to delete this highlight?