Fed: Fall in market confidence, profitability among the main risks for banks

WASHINGTON — Key indicators of banking sector health fell to their lowest levels in more than a year during the first quarter, signaling trouble on the horizon, especially for smaller institutions.

The semi-annual report on supervision and regulation from the Federal Reserve Board of Governors, released on Friday, shows that the banking sector is relatively sound. A $230 billion inflow of common stock since the start of the pandemic has given institutions a large buffer for potential losses. Liquidity, at 28%, is also well above the five-year industry average.

Relationships with investment funds, third-party service providers and fintechs will be top priorities for Federal Reserve supervisors this year, according to the semi-annual Fed Supervision and Regulation Report.

Overall loan delinquency also fell below 1%, the lowest rate since 2006.

Yet the report also highlighted some emerging red flags. He noted that the market’s overall leverage ratio – which measures confidence in banks’ capital – fell to its lowest level since February 2021. Meanwhile, credit default swap spreads hit their lowest point. highest level since spring 2020.

The Fed attributes the uncertainties caused by the Russian invasion of Ukraine to the deterioration of market confidence. While US banks have little direct country exposure, the conflict has impacted commodity prices and created volatility in many consumer-facing industries. Banks are also more vigilant about cybersecurity threats that could come in retaliation for US sanctions against Russia.

Bank profitability was already in decline before Russian troops advanced on Ukraine in late February, according to the Fed report. Returns on assets and average equity, the two measures used to assess profitability, declined in each of the last three quarters of 2021. (Results for the first quarter of this year were not included in the report .) The Fed attributes the decline to increased lending. losses and lower transaction volume for large banks, although he notes that these institutions expect higher margins this year as interest rates on bank assets rise.

Community and regional banks, those with less than $10 billion and between $10 billion and $100 billion in assets, respectively, face the greatest risks, the report notes. While most of these organizations remain well capitalized, their books also tend to have a higher concentration of commercial real estate loans, many of which have struggled during the pandemic. Operationally, smaller banks are also less equipped to deal with cyber threats than their larger counterparts, the report notes.

Cybersecurity will be a top priority for the Fed this year, according to the report. Supervisors will be keenly interested in the controls banks have in place to manage access to their systems and information. They will also focus on how banks identify and respond to ransomware attacks.

After the collapse of investment firm Archegos Capital Management, which led to the loss of $10 billion at several major banks, Fed supervisors will take a closer look at relations with counterparties, the report says, in particular when it comes to prime brokerage accounts for large fund managers. . Other top monitoring priorities for 2022 will be engagements with third-party service providers and with fintech companies.

Researchers at Cowen Inc., a New York-based investment firm, said the Fed’s overall findings paint a favorable picture for the banking sector. However, based on the red flags noted in the report, the company expects the Fed to step up its capital requirements for banks in the near future and take a more skeptical approach to bank mergers and acquisitions.

“Despite our positive assessment of the report, we still expect Federal Reserve Democrats to toughen the [Comprehensive Capital Analysis and Review] stress test in a way that effectively raises capital requirements for large banks by an additional 100 to 200 basis points,” the company said in a statement. “Nor do we see the report as improving the environment for banking mergers and acquisitions, as the regulatory focus there is less on the current health of banks and more on how to oversee increasingly large institutions.”