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Condition of the Federal Banking System

The condition of the federal banking system is strong. The economic environment through 2018 supported loan growth and bank profitability. Asset quality, as measured by traditional metrics such as delinquencies, nonperforming assets, and losses, is sound. Capital and liquidity are near historical highs, and earnings are improving. Recent examination findings indicate improvement in banks’ overall risk management practices. Also, mergers and acquisitions activity is beginning to increase.

This section highlights these factors contributing to the federal banking system's condition:

Composition

At the end of 2018, the federal banking system comprised 1,264 banks, federal savings associations, and federal branches and agencies operating in the United States (collectively, banks). These banks range from small community banks1 to the largest, most globally active U.S. banks. Of these banks, 1,010 have less than $1 billion in assets, while 62 have more than $10 billion. In total, the banks within the federal banking system hold $12.5 trillion of all assets of U.S. commercial banks. The federal banking system holds two-thirds of credit card balances in the country and services almost half of all residential mortgages. Through these products and services, a majority of American families have one or more relationships with an OCC-supervised bank.

Figure 1: Federal Banking System at a Glance*

In 2018, there were a total of 1264 OCC supervised institutions, with a total of $12.5 trillion in assets.  These institutions were 891 National banks, 316 Federal savings associations, and 57 Federal branches and agencies.

* Number of banks as of September 30, 2018.

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Capital and Liquidity

Banks, particularly large banks, have substantially increased the volume and quality of capital and strengthened risk management practices to enhance the quality and reliability of capital and liquidity planning. These practices, which include the use of stress testing and more stable funding and monitoring of liquidity, have had a positive effect on the overall strength of capital and liquidity in the federal banking system.

Robust Capital
The level and quality of bank capital has stabilized at healthy levels, in part through the concerted effort of regulators and bankers over the past few years. Tier 1 capital, which includes shareholders’ equity and retained earnings, is a common key measure of the industry’s health. Tier 1 capital provides protection for banks to absorb losses and supports the resiliency of the federal banking system. Tier 1 capital reached 13 percent of risk-weighted assets in 2017 and remained there in 2018.

Stress tests help determine whether the industry can weather a crisis. Positive results reassure the public that the federal banking system is safe and sound. Current capital levels suggest that the nation’s largest bank holding companies are strongly capitalized and would be able to lend to households and businesses during a severe global recession, according to the results of supervisory stress tests released in June 2018 by the Board of Governors of the Federal Reserve System.

Stable Liquidity
Liquidity is the ready access to funds on reasonable terms. The OCC examines banks’ liquidity levels and risk management to determine whether bank liquidity can meet banks’ financial obligations and fulfill the banking needs of their communities.

The largest banks have improved their quantity and quality of liquidity. Liquid assets in the banking system increased after the liquidity coverage ratio rule, which requires banks to hold sufficient highly liquid assets to meet short-term outflows in stress situations, took effect last year. One historically available measure shows that liquid assets2 have now stabilized near a 30-year high of 16 percent of total assets in 2018.

Figure 2: Capital and Liquidity

Tier 1 Capital Ratio averaged 9.8% from 1992-2007, with a crisis low at 9.24%.  It was 13.0% in the third quarter of 2018.  The Liquidity Ratio averaged 3.93% from 1992-2007, with a crisis low at 2.52%.  It was 15.90% in the third quarter of 2018.

Capital and liquidity are the building blocks of the federal banking system’s resiliency. The tier 1 capital ratio is 42 percent higher than in 2008, which represents the low point in the financial crisis. The liquidity ratio is six times the crisis low. Both ratios exceed their 15-year pre-crisis averages.

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Financial Performance

Federal banking system profitability benefited from strong underlying performance and tax cuts3 in the first three quarters of 2018.4 Return on equity jumped to 12.1 percent, exceeding the 10 percent benchmark return for the first time since 2006. Return on average assets of 1.4 percent reflected a 44-basis-point improvement over the past year. Net income grew 28 percent to $121 billion from the year earlier period with tax cuts accounting for about 40 percent of the increase.5 Pre-tax income rose 12 percent to $156 billion, reflecting strong revenue growth. Net interest income continued to increase at an 8 percent pace, spurred by margin expansion at banks of all sizes. Noninterest income growth accelerated to 6 percent from nearly flat a year earlier. Provisions for loans losses declined 5 percent. Noninterest expense growth picked up a bit, but expenses grew more slowly than revenues.

Operating Profit
Pre-provision net revenues rose by $16.0 billion (9.7 percent) in the first three quarters of 2018 compared with a year earlier. After years of low interest rates, rising interest rates made net interest income the primary earnings driver in 2017, with the trend continuing in 2018.

Net interest margins expanded as asset yields rose faster than funding costs. Funding costs benefited from the elevated level of low-cost core deposits6—effectively funding nearly 60 percent of total assets, a 25-year high. Over the past year, net interest margins rose 18 basis points to 3.39 percent, the highest margin since 2012 for the federal banking system. At community banks, margins expanded by 11 basis points to 3.78 percent, the highest margin since 2011. Increasing competition for deposits could begin to temper margin improvement going forward.

Figure 3: Bank Profitability

Bank profitability (return on assets [ROA] and the percentage of profitable banks [PPB]) are back to pre-crisis levels. ROA in 2005 was 1.26%, in 2009 was .02%, and in 2018 was 1.26%.  PPB was 94.55% in 2005, 70.91% in 2009, and 95.69% in 2018.

The federal banking system's recovery over the 10 years since the financial crisis demonstrates its resiliency. Bank profitability is steadily improving with 2018 earnings on pace to reach $162 billion. Both return on assets and the share of profitable banks are back to pre-crisis levels.

Loan Performance
Overall loan performance has improved annually since 2010, though there was a small uptick in net charge-offs in 2018. The credit cycle remains benign with loan loss rates in the first three quarters of 2018 well below their 25-year average for the federal banking system. Total nonperforming assets continue to decline, reaching a 10-year low of 0.66 percent of loans as of September 30, 2018. Reserve coverage is stable for total loans at 1.3 percent but is improving for noncurrent loans—reaching 116 percent of noncurrent loans, slightly above its 25-year average.

Figure 4: Credit Quality

The percentage of loans that were 30 days past due was at a crisis high of 2.20%, with a 25 year average of 1.19%, and 3rd quarter 2018 loans at .70%.  Noncurrent loans were at a crisis high of 6.02%, with a 25 year average of 2.08%, and 3rd quarter 2018 loans at 1.13%.  Net charge-offs were at a crisis high of 3.38%, with a 25 year average of .94% and a 3rd quarter percentage of .53%.

Credit quality ratios are below their 25-year averages, and credit quality is not a hindrance to loan growth. Loans 30 days past due include the share of total loans that are 30 to 89 days past due. Noncurrent loans are the share of total loans that are 90 or more days past due or on nonaccrual status. Net charge-offs are the share of total loan balances charged off as a loss, net of recoveries.

Conclusion
To strengthen their balance sheets, many banks increased capital over the past several years, mostly by retaining earnings. Equity to assets rose from 10.1 percent in 2007 to 11.1 percent as of third-quarter 2018 for the system and from 10.9 percent to 11.7 percent for community banks. The result is a stronger banking system than before the 2008 financial crisis.

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Risk Perspective

Banking is essentially a business of managing risk, and banks’ risk identification, assessment, monitoring, and management affect the condition of the federal banking system. The OCC’s supervision focuses on evaluating banks’ ability to identify, measure, monitor, and control risks. The OCC monitors the condition of the federal banking system, identifies and assesses key supervision risks, and takes action to respond to those risks. The OCC communicates its assessment of risk in the federal banking system in the Semiannual Risk Perspective.

Key risks include

  • incremental easing in commercial credit underwriting practices.
  • bank risk management of cybersecurity threats.
  • third-party concentration risk for certain products and services.
  • complex money-laundering and terrorism-financing methods that pose challenges in complying with the BSA.
  • challenges to compliance management processes in implementing and maintaining an effective compliance program for consumer protection regulations.
  • potential effects of rising interest rates, increasing competition for retail and commercial deposits, and post-crisis liquidity regulations for banks with total assets of $250 billion or more, on the mix and cost of deposits.

The potential effect of rising interest rates on deposit mix and cost was added as a key risk issue in the spring of 2018. In addition, the integrated mortgage disclosure requirements under the Truth in Lending Act and the Real Estate Settlement Procedures Act were downgraded from a key risk to an issue that warrants monitoring.

Operational risk is elevated as banks adapt business models, transform technology and operating processes, and respond to evolving cyber threats.

Compliance risk remains elevated as banks manage money-laundering risks in a complex environment. Implementing changes to policies and procedures to comply with amended consumer protection requirements also test banks’ compliance risk management processes.

Lastly, there is uncertainty in how bank deposits will react to increasing interest rates. Banks may experience unexpected adverse shifts in liability mix or increasing costs that may adversely affect earnings or increase liquidity risk.

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Diversity

The OCC administers a minority depository institution (MDI) program to provide technical assistance and other support to OCC-supervised MDIs, promoting and preserving these banks consistent with requirements set forth in law. The OCC’s 2017 Annual Report: Preservation and Promotion of Minority-Owned National Banks and Federal Savings Associations, published in June 2018, addresses the condition of these institutions and the OCC’s actions in support of this program.

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1 For purposes of this report, community banks are national banks and FSAs with less than $1 billion in total assets and exclude trust and credit card institutions.
2 Liquid assets are defined as cash, net Federal Reserve funds, and U.S. Treasury securities.
3 The Tax Cuts and Jobs Act, passed in December 2017, effectively cut tax rates for all banks except subchapter S banks (typically smaller banks), which pass income through directly to owners to be taxed at the owners’ personal tax rates.
4 Data for only the three quarters of calendar year 2018 were available by publication deadline.
5 Income and expense data are merger-adjusted and held constant for institutions in continuous operation from the third quarter of 2010 through the second quarter of 2018.
6 Core deposits are total domestic deposits excluding large time deposits of more than $250,000 and brokered deposits. Before 2010, core deposits excluded time deposits of more than $100,000.