Academic journal article Federal Reserve Bulletin

Recent Developments in the Profitability and Lending Practices of Commercial Banks

Academic journal article Federal Reserve Bulletin

Recent Developments in the Profitability and Lending Practices of Commercial Banks

Article excerpt

Recent Developments in the Profitability and Lending Practices of Commercial Banks Martin H. Wolfson and Mary M. McLaughlin, of the Board's Division of Monetary Affairs, prepared this article. Douglas Carpenter and Vernon McKinley provided research assistance. The profitability of U.S.-chartered insured commercial banks recovered in 1988, after a year of record low earnings. Large banks registered the sharpest turnaround; their rates of profitability were the highest in many years after huge losses in 1987. At all commercial banks, the lowest level of loss provisions in five years, in conjunction with higher net interest income, contributed to a return on assets of 0.84 percent, the highest in two decades. The return on equity increased sharply to 13.52 percent. This strong performance allowed banks to pay dividends to shareholders that were generous by historical standards, while still increasing their equity capital ratios somewhat. Banks chose to provision at a lower level last year, even though charge-offs increased, particularly on foreign loans. Net charge-offs in fact exceeded provisions, and consequently, banks ended 1988 with loss reserves down from a year earlier.

Short-term interest rates rose steadily throughout most of last year as the Federal Reserve took steps to restrain inflation. With the demand for bank credit generally strong and its cost rising, the rate of return on banks' loan portfolios rose significantly. In contrast, rates paid on many retail deposits at commercial banks adjusted only partially to the increases in market rates. As a result, the spread between interest income and interest expense (net interest margin) widened.

Despite strong domestic demand for loans, overall asset growth of U.S. banks remained moderate last year. Acquisitions of securities slowed, in part to accommodate higher domestic loan growth in the context of tighter monetary policy and in part as a result of the continued runoff of tax-exempt securities following the 1986 tax law change. Foreign loans declined as large banks reduced their exposure to developing countries by recognizing losses and slowing new loan growth. Partly to improve capital ratios, money center banks reduced their assets by stepping up loan sales and striving to pare back holdings of narrow-margin assets.

In their funding strategy last year, banks relied heavily on both large and small time deposits. In contrast to other retail deposits, interest rates paid on small time deposits generally kept pace with rising market rates, and the rate of growth of these deposits picked up sharply. In the category of managed liabilities, a strong advance in large time deposits reflected in part a shift of funding sources from foreign office deposits, which declined.

A record 198 commercial banks insured by the Federal Deposit Insurance Corporation failed last year. As in 1987, the majority of the nation's failed banks were located in the Southwest, where real estate losses remained high. On the other hand, the farm economy continued to improve last year, despite the drought, and the profitability of agricultural banks exceeded that of the banking system as a whole.

BALANCE SHEET DEVELOPMENTS

Interest-Bearing Assets Expansion of bank credit increased slightly last year, as a marked slowdown in the acquisition of securities offset an acceleration in the growth of loans. All size groups of banks registered strong loan growth except for money center banks, at which loan volume contracted. The fastest-growing component of bank credit was real estate loans. Domestic business loans registered a sharp increase in their growth rate, while foreign business loans contracted. Growth of U.S. government securities slowed while municipal securities ran off. At large banks, holdings of total securities shrank. Several very large banks that act as primary dealers of government securities registered declines in their security holdings because their parent holding companies spun off their dealer departments into nonbank subsidiaries. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.