Financial Condition of Depository Banks
Darryl E. Getter
Specialist in Financial Economics
March 18, 2013
Congressional Research Service
7-5700
www.crs.gov
R43002
CRS Report for Congress
Pr
epared for Members and Committees of Congress

Financial Condition of Depository Banks

Summary
A bank is an institution that obtains either a federal or state charter that allows it to accept
federally insured deposits and pay interest to depositors. In addition, the charter allows banks to
make residential and commercial mortgage loans; provide check cashing and clearing services;
underwrite securities that include U.S. Treasuries, municipal bonds, commercial paper, and
Fannie Mae and Freddie Mac issuances; and other activities as defined by statute.
Congressional interest in the financial conditions of depository banks or the commercial banking
industry has increased in the wake of the financial crisis that unfolded in 2007-2009, which
resulted in a large increase in the number of distressed institutions. A financially strained banking
system would have difficulty making credit available to facilitate macroeconomic recovery.
The financial condition of the banking industry can be examined in terms of profitability, lending
activity, and capitalization levels (to buffer against the financial risks). This report focuses
primarily on profitability and lending activity levels. Capitalization issues are discussed in CRS
Report R42744, U.S. Implementation of the Basel Capital Regulatory Framework, by Darryl E.
Getter.
The metrics related to asset performance and earnings show an increase in profitability for the
banking industry although many small bank institutions are still experiencing distress. Non-
current loans still exceed the capacity of the banking industry to absorb potential losses if they
were all to become uncollectible. Consequently, lending activities are likely to be restrained until
bank loan-loss capacity as well as overall economic conditions improve. Furthermore,
profitability in banking is not likely to indicate that pre-crisis lending patterns have resumed.
Given the required increases in capitalization buffers to absorb loan defaults as well as the
(expected) costs associated with funding loans, profitability trends may differ for banks by size,
particularly after accounting for differences in the revenue generating activities of small and large
banks.

Congressional Research Service

Financial Condition of Depository Banks

Contents
Introduction ...................................................................................................................................... 1
Important Definitions and Distribution by Size ............................................................................... 2
Overview of Bank Industry Conditions ........................................................................................... 4
Overview of Revenue Composition by Bank Size ........................................................................ 11
Conclusion ..................................................................................................................................... 15

Figures
Figure 1. FDIC-Insured Institutions by Asset Size and Industry Asset Holdings ............................ 4
Figure 2. Total FDIC Insured, Total Problem, Total Unprofitable Institutions ................................ 5
Figure 3. Return on Assets, Return on Equity ................................................................................. 7
Figure 4. Non-Current Assets, Net Charge-Offs, Allowances for Loan & Lease Losses
(ALLL Proxy) ............................................................................................................................... 8
Figure 5. Coverage Ratio ............................................................................................................... 10
Figure 6. Asset Growth Rate .......................................................................................................... 11
Figure 7. Net Interest Margins by Bank Size Categories ............................................................... 13
Figure 8. Percentage of Non-Interest Income by Bank Size Categories ........................................ 14

Contacts
Author Contact Information........................................................................................................... 15

Congressional Research Service

Financial Condition of Depository Banks

Introduction
Financial intermediation is the process of matching savers, who are willing to lend funds to earn a
future rate of return, with borrowers, who are presently in need of funds to make transactions. It is
expensive, however, for savers to locate, underwrite, and monitor repayment behavior of
borrowers. Similarly, it is expensive for borrowers to locate a sufficient amount of savers with
funds and favorable lending terms. Hence, banks develop expertise in intermediation, or
facilitating the transfer of funds from savers to borrowers. Although other institutions (e.g., credit
unions, insurance companies, pension funds, hedge funds) also engage in the financial
intermediation matching process, this report examines how depository banks are faring in this
activity.
A commercial or depository bank is typically a corporation that obtains either a federal or state
charter to accept federally insured deposits and pay interest to depositors; make residential and
commercial mortgage loans; provide check cashing and clearing services; and may underwrite
securities that include U.S. Treasuries, municipal bonds, Fannie Mae and Freddie Mac issuances,
and commercial paper (unsecured short-term loans to cover short-term liquidity needs). The
permissible activities of depository banks are defined by statute.1
The typical intermediation transaction made by banks consists of providing loans to borrowers at
higher rates than the cost to borrow the funds from savers, who provide loanable funds in the
form of bank deposits. Banks profit from the spread between the rates they receive from
borrowers and the rates they pay to depositors. Facilitation of the intermediation transaction
involves risk. Banks face the risk that borrowers can default on their loans, making it more
difficult to repay depositors. In addition, banks face funding or liquidity risk stemming from more
frequent movements in short-term interest rates. Banks must have access to an uninterrupted
source of short-term funding (deposits) until its long-term loans are fully repaid, which is
explained in more detail later in this report, and fluctuations in short rates translates into
fluctuations in their profit spreads. Furthermore, depositors could suddenly and simultaneously
decide to withdraw their deposits, perhaps due to a sudden change in economic conditions or even
speculation about deteriorating economic conditions, resulting in financial distress for a bank or
several banks.2 Hence, bank profitability and financial risk are inextricably linked.
In addition to default and funding risks, financial intermediation increases the vulnerability of
borrowers to economic downturns. During business cycle booms, lenders may grow optimistic

1 Underwriting in banking refers to two types of activities. Loan underwriting occurs when a bank performs a (default)
risk assessment of a potential borrower to determine whether to extend credit (loanable funds), the amount, and how
much to charge the borrower. Securities underwriting occurs when a bank agrees to take on the risk of distributing
securities (in the form of bonds or stocks) of another entity that wishes to attract outside investors to provide funding.
If, however, the bank is unable to find enough interested investors, then it retains any unsold securities and assumes the
default risk associated with the entity. The Glass-Steagall Act restricts the securities underwriting activities of
depository banks. Depository banks may underwrite federal, state, and local government securities as well as the
securities guaranteed by federal or state governments; but they are not allowed to underwrite equity securities
(corporate stock). See CRS Report R41181, Permissible Securities Activities of Commercial Banks Under the Glass-
Steagall Act (GSA) and the Gramm-Leach-Bliley Act (GLBA)
, by David H. Carpenter and M. Maureen Murphy.
2 This phenomenon is known as a bank run. The federal deposit insurance system in the United States was established
in the1930s to insure deposits, which helps to sustain public confidence and avoid runs on U.S. banks. See CRS Report
R41718, Federal Deposit Insurance for Banks and Credit Unions, by Darryl E. Getter.
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Financial Condition of Depository Banks

and increase credit availability as if the ideal economic and financial market conditions will
persist.3 The trade-off or costs associated with an expansion of lending is a corresponding rise in
the severity of financial distress should economic conditions suddenly deteriorate. In other words,
recessions that occur when individuals have more loan repayment obligations (or more leveraged
financially) are likely to be more arduous, in particular if these individuals (via job losses or pay
cuts) suddenly face lower income prospects.
Hence, U.S. depository banks are required to comply with safety and soundness regulations,
which are designed to monitor and buffer against the types of financial intermediation risks that
can result in financial distress for banks and the broader economy. The propagation of
intermediation risks is curbed when lending activity is restrained, but there is a cost associated
with a reduction of financial risk. Recessions are likely to be milder when fewer loan repayment
obligations are outstanding, but the trade-off is a less robust economic expansion. Fewer loans
translate into fewer transactions that could possibly have spurred greater economic activity.4
Consequently, determining how much financial intermediation risk is optimal for the banking
system to take while simultaneously trying not to undermine economically stimulative lending
activity is often a regulatory challenge.
Congressional interest in the financial conditions of depository banks, also referred to as the
commercial banking system, has increased following an increase in distressed institutions and
widespread credit tightening. The conditions of the banking industry can be examined in terms of
profitability, lending activity, and capitalization levels (to buffer against the financial risks); but
this report focuses primarily on profitability and lending activity levels. Particular attention will
be paid to metrics related to asset performance and earnings of depository banks. These measures
show that profitability for the banking industry has improved, but lending activity has not
returned to pre-crisis levels.
Important Definitions and Distribution by Size
This report discusses the depository (commercial) banking institutions as having one aggregate
balance sheet. The following balance sheet terminology is used.
• Bank assets include long-term consumer, residential, and commercial loans that
banks originate as well as cash and other financial securities that they hold in
their asset portfolios. Bank assets will generate earnings (revenues) or losses,
depending upon whether customers repay or default on their loans.
• Bank liabilities include the funds that they borrow. When customers (depositors)
make savings or checking deposits into a bank, the bank is essentially borrowing
those funds for short periods of time in order to lend them out for longer periods
of time. The interest paid for these borrowings are, therefore, the costs incurred
by the bank to obtain the funds necessary to originate new loans.

3 See Hyman P. Minsky, The Financial Instability Hypothesis, The Jerome Levy Economics Institute, Working Paper
no. 74, May 1992.
4 Bank capital levels may become less effective at reducing intermediation risks if lending activities migrate outside of
the regulated banking system and are conducted by institutions that do not hold federally insured deposits.
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• Bank capital is the difference between the value of assets and liabilities. Bank
capital includes items such as common shareholder equity, retained earnings, and
provisions set aside for loan and lease losses (discussed in more detail below).
Banks that accept federally insured deposits are required to maintain sufficient
capital reserves to protect bank creditors from loan defaults by bank customers.
Asset (loan) defaults are less likely to result in failure of a bank to repay its
shorter-term obligations if sufficient capital is maintained to absorb the losses. If,
however, a bank’s capital falls below minimum regulatory threshold levels, it
would be considered undercapitalized and faces the prospect of being shut down
by its regulator, which typically appoints the Federal Deposit Insurance Company
(FDIC) 5 as the receiver of the insolvent institution. Consequently, compliance
with regulatory capital requirements implies that capital reserves must grow
proportionately with bank asset (lending) portfolios.6
Assets in the banking industry are not evenly distributed, which means that banking firms are not
identical and, for some metrics, must be analyzed separately to get a more accurate assessment of
financial conditions. Using data from the FDIC, Figure 1 illustrates the number of U.S. banks
over time by the following size categories of bank asset holdings (defined below): less than $100
million, $100 million-$1 billion, $1 billion-$10 billion, and greater than $10 billion. Community
banks are commonly defined as financial institutions with total assets below $1 billion.7 At the
other extreme are the large financial institutions that have $10 billion or more in assets. The
number of banks with more than $10 billion in assets has remained relatively constant, ranging
from 95 to 108 institutions over the period.
Figure 1 also shows the dollar amount of bank assets in millions of dollars. As of 2012, the FDIC
reports that industry assets were $14,450.67 billion. For several decades, bank assets have
increased while the number of banking institutions has declined. The smallest of the community
banks, those with less than $100 million and collectively holding approximately 1% of all
industry assets, have accounted for most of the industry consolidation even prior to the 2007-
2009 recession. Banks with more than $10 billion in assets collectively hold approximately 80%
of all industry assets. Consequently, profitability and lending activities may differ by bank size.

5 When a bank fails, the Federal Deposit Insurance Corporation (FDIC) typically closes the institution and administers
the repayment of depositors. See CRS Report R41718, Federal Deposit Insurance for Banks and Credit Unions, by
Darryl E. Getter.
6 Regulators require banks to maintain minimum capital-asset ratio levels, thus maintaining the proportional growth of
assets and capital. Capital-asset ratios are computed by placing a financial institution’s total capital in the numerator of
the ratio and then dividing by its total assets, which are usually weighted by degree of default risk. Note that this
analysis will focus primarily on the component of capital most closely associated with loan losses rather than discuss
the more complex aspects of capital regulation. See Douglas J. Elliot, “A Primer on Bank Capital,” The Brookings
Institution, January 28, 2010, at http://www.brookings.edu/~/media/research/files/papers/2010/1/
29%20capital%20elliott/0129_capital_primer_elliott.pdf; and CRS Report R42744, U.S. Implementation of the Basel
Capital Regulatory Framework
, by Darryl E. Getter.
7 An alternate and more extensive definition of a community bank is associated with its functions as opposed to its asset
size. See Federal Deposit Insurance Corporation, FDIC Community Banking Study, Washington, DC, December 2012,
at http://www.fdic.gov/regulations/resources/cbi/report/cbi-full.pdf.
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Financial Condition of Depository Banks

Figure 1. FDIC-Insured Institutions by Asset Size and Industry Asset Holdings
2000-2012
12000
16,000,000
14,000,000
10000
ions
ut

12,000,000
it
ns)
st
8000
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10,000,000
illio
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er
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s (in
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sset
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To
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Q1
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Q1
Q1
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Q1
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Q1
Q1
Quarters
Assets > $10 Billion
Assets $1 Bil ion - $10 Bil ion
Assets $100 Million - $1 Billion
Assets < $100 Mil ion
Total Assets (in $Millions)

Source: FDIC.
Notes: The number of institutions holding $10 billion or more in assets appears as red dots sitting on the
horizontal axis. The number of institutions range from 95 to 108 over the entire period.
Overview of Bank Industry Conditions
The banking system has recently seen unusually high numbers of distressed institutions, with
failures at rates not seen since the savings and loan crisis that began in 1980 and lasted through
the early 1990s.8 The number of banks that failed, or fell substantially below their minimum
capital reserve requirements, increased as the financial crisis of 2008 unfolded. No banks failed in
2005 and 2006, and only three bank failures occurred in 2007.9 In contrast, the FDIC
administered 25 bank failures in 2008, 140 bank failures in 2009, 157 bank failures in 2010, and
92 bank failures in 2011. In 2012, there were 51 bank failures.10
Of the 7,083 FDIC-insured institutions in 2012, the FDIC reports that approximately 35%
reported negative quarterly income at various quarters after the financial crisis; the percentage of
these unprofitable institutions fell to 10.48% in 2012. The FDIC also maintains a problem list of
banks at risk of failure because their capital reserves have fallen below regulatory minimum

8 See Federal Deposit Insurance Corporation, Division of Research and Statistics, Chapter 4: The Savings and Loan
Crisis and Its Relationship to Banking
, History of the Eighties—Lessons for the Future: An Examination of the
Banking Crises of the 1980s and Early 1990s, Washington, DC, at http://www.fdic.gov/bank/historical/history/
167_188.pdf.
9 See FDIC Quarterly Banking Report as of December 31, 2009, at http://www2.fdic.gov/qbp/2009dec/qbp.pdf.
10 See FDIC Quarterly Banking Report as of December 31, 2012, at http://www2.fdic.gov/qbp/2012dec/qbp.pdf.
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Financial Condition of Depository Banks

levels (but perhaps not yet far enough below to be shut down). The number of depository
institutions on the FDIC’s problem list rose from 52 banks in 2005, peaked at 888 in the first
quarter of 2011, before falling to 651 by the end of 2012. The assets of the problem institutions,
however, total $232.7 billion, representing approximately 1.6% of total industry assets. Hence,
small institutions are likely to still be experiencing financial distress. Figure 2 shows the number
of FDIC-insured banks, the number of problem banks, and the number of unprofitable institutions
by quarter since 2005. Note that an unprofitable institution may not also be counted on the
FDIC’s problem institution list if it has enough capital to absorb its quarterly revenue shortfalls
and still meet the adequately capitalized or well-capitalized thresholds.11
Figure 2. Total FDIC Insured, Total Problem, Total Unprofitable Institutions
2005-2012
3500
10000
9000
3000
8000

2500
7000
ions
tions
stitut
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itu
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1 2
2 2
3 2
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1 2
2 2
3 2
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1 2
2 2
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4 2
1 2
2 2
3 2
4 2
1 2
2 2
3 2
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1 2
2 2
3 2
4 2
1 2
2 2
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1 2
2 2
3 2
4 2
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Quarters
Problem Institutions (Left Hand Side)
Number Institutions Reporting Negative Quarterly Net Income (Left-Hand Side)
Total FDIC Insured (Right Hand Side)

Source: FDIC.
Notes: The number of institutions reporting negative quarterly net income is computed by multiplying the total
number of FDIC-insured institutions by the percentage of unprofitable institutions reported by the FDIC.

11 The italicized terms refer to the capitalization categories established under the Prompt Corrective Action system of
bank regulatory rules, which may be found at http://www.fdic.gov/regulations/laws/rules/2000-4400.html.
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Financial Condition of Depository Banks

The industry is returning to profitability. The FDIC reports that industry net income rose to
$141.3 billion, representing the highest net income level since 2006.12 Although lending growth
has increased, the FDIC reports that most of the earnings increase can be attributed to increases in
noninterest (fee) income and lower provisions set aside for anticipated loan losses, which will be
discussed below.
Return on assets (RoA) and return on equity (RoE) are commonly used metrics to gauge bank
profitability. RoA is computed with net income (total assets minus total liabilities) in the
numerator and average total assets in the denominator. The RoA measures the financial return of a
bank’s average assets or lending activities. Given that the banking industry relies heavily upon
borrowed liabilities to fund assets, the numerator of the ratio would be significantly smaller than
the denominator; therefore, a RoA of approximately 1% is considered profitable.13 RoE is
computed with net income in the numerator and the total amount of common shareholder equity
in the denominator. The RoE is a measure of financial return for shareholders. Unlike RoA, RoE
does not have a barometer of “acceptable” performance because it can increase due to either asset
profitability or depleting capital positions, making it difficult to establish a benchmark standard.14
The FDIC reported industry declines in both RoA and RoE during the 2007-2009 recession as the
numerators of both ratios fell even faster than their denominators. The negative returns coincided
with the wave of loan defaults that also occurred during the recession, which led to deterioration
of capital, increases in the number of banks on the FDIC’s problem list, and increases in bank
failures. The RoA and RoE measures, which are illustrated in Figure 3, have exhibited a reversal
in course since the recession.

12 See FDIC press release at http://fdic.gov/news/news/press/2013/pr13014.html.
13 See Ricki Helfner, chairman, “On the Release of the Quarterly Banking Profile,” Speech at Federal Deposit
Insurance Corporation, Washington, DC, September 12, 1995, at http://www.fdic.gov/news/news/speeches/archives/
1995/sp12sept95.html.
14 See European Central Bank, Beyond RoE—How to Measure Bank Performance, Appendix to the Report on EU
Banking Structures, Germany, September 2010, http://www.ecb.europa.eu/pub/pdf/other/
beyondroehowtomeasurebankperformance201009en.pdf.
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Figure 3. Return on Assets, Return on Equity
2000-2012
20%
15%
10%
5%
rn
tu
Re

0%
-5%
-10%
-15%
2000Q1
2001Q1
2002Q1
2003Q1
2004Q1
2005Q1
2006Q1
2007Q1
2008Q1
2009Q1
2010Q1
2011Q1
2012Q1
Quarters
ROA
ROE

Source: FDIC.
As previously stated, declines in RoA and RoE may be attributed to loan repayment problems that
led to an increase in the numbers of distressed institutions. Non-current assets are loans that
borrowers do not repay as scheduled. The allowances for loan and lease losses (ALLL) is a
component of regulatory bank capital set aside for anticipated (or estimated) loan losses. Loan
loss provisioning
refers to increasing the amount of ALLL when loan default risks increase;
decreases are referred to as charge-offs or deductions from ALLL when lenders determine that
non-current assets will not be repaid.15 Figure 4 shows the increase in both noncurrent assets and
charge-offs after 2007.
Banking organizations are required to hold capital for both anticipated and unanticipated default
risks. The federal bank regulators believe that most banking organizations already hold sufficient
capital to meet the proposed higher requirements to buffer against unanticipated losses.16 On the

15 Net charge-offs are charge-offs minus the delinquent loans that recover. Mortgage and credit card charge-offs differ.
A credit card loan charge-off can be recognized immediately, but writing off mortgages takes considerably more time.
When it becomes clear that a mortgage default cannot be cured, the property is generally seized via foreclosure and
must be resold to recover some losses. For more information on the foreclosure process, see Appendix A of CRS
Report R41572, Incentives and Factors Influencing Foreclosure and Other Loss Mitigation Outcomes, by Darryl E.
Getter.
16 See Department of the Treasury: Office of the Comptroller of the Currency, Federal Reserve System, Federal
Deposit Insurance Corporation, “Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Minimum
Regulatory Capital Ratios, Capital Adequacy, Transition Provisions, and Prompt Corrective Action,” 77 Federal
Register
52796, August 30, 2012 at http://www.gpo.gov/fdsys/pkg/FR-2012-08-30/pdf/2012-16757.pdf; and U.S.
Congress, Senate Committee on Banking, Housing, and Urban Affairs, Basel III, Testimony of Michael S. Gibson,
Director, Division of Banking Supervision and Regulation, Federal Reserve Board, 112th Cong., 2nd sess., November
(continued...)
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other hand, ALLL requirements change more frequently (quarterly) or when expected credit
losses may have increased. Hence, a bank may have sufficient capital to meet unanticipated
defaults, which may be associated with unforeseen events (such as a sudden increase in the
unemployment rate), but it may still need to increase ALLL provisions should a borrower begin
showing signs of repayment difficulties that may go into default. If banks can absorb anticipated
loan losses using current income earnings, their capital will be left intact for unanticipated losses.
Figure 4. Non-Current Assets, Net Charge-Offs, Allowances for Loan & Lease Losses
(ALLL Proxy)
2002-2012
4.00%
3.50%
3.00%
s
2.50%
sset
A

2.00%
1.50%
tal Bank
o
f T

1.00%
tage o
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0.50%
ce
Per

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3 20
1 20
3 20
1 20
3 20
1 20
3 20
1 20
3 20
1 20
3 20
1 20
3 20
1 20
3 20
Q
Q
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Q
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Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Quarters
Net Charge-Offs
Non-Current Assets
ALLL Proxy

Source: FDIC.
Notes: The ALLL proxy is computed by CRS using FDIC data.
The FDIC reports a continued decline in aggregate ALLL provisioning as of 2012.17 As
mentioned earlier, the FDIC reported that lower levels of provisions that were set aside for
distressed loans was an important factor in determining industry profitability in 2012. The ratio of

(...continued)
14, 2012 at http://www.federalreserve.gov/newsevents/testimony/gibson20121114a.htm.
17 ALLL provisioning declined for thirteen consecutive quarters as of December 31, 2012. For more details on the
decline in loan loss provisions, see FDIC Quarterly Banking Reports for March 31, 2012 at http://www2.fdic.gov/qbp/
2012mar/qbp.pdf and December 31, 2012 at http://www2.fdic.gov/qbp/2012dec/qbp.pdf.
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Financial Condition of Depository Banks

aggregate ALLL provisioning to total bank assets, also shown in Figure 4, is an ALLL proxy
indicating that loan loss provisioning matched and often exceeded the anticipated percentage of
problem assets prior to 2007, which are composed of net charge-offs and non-current assets.18
The ALLL indicator suggests that the amount of loan loss provisioning after the end of 2012
appears to cover net charge-offs; however, the percentage of non-current loans must decline even
more relative to the current level of ALLL provisioning (or ALLL provisioning must increase
more) before the industry can fully cover its anticipated default risks.
Although the ALLL indicator in Figure 4 was constructed for illustrative purposes, the coverage
ratio
, which is defined as the amount of loan loss reserves and equity per dollar of noncurrent
loans, is more commonly used to assess the extent of non-performing assets relative to ALLL
levels.19 Despite industry efforts to increase loan loss provisioning, the more rapid pace of non-
current loans led to a substantial decline in the industry coverage ratio, shown in Figure 5. A
coverage ratio below 100% indicates that there is insufficient ALLL to cover weak loans that
could go into further distress. Consequently, regulators are requiring banks to increase loan loss
provisioning (as well as other components of regulatory capital) to levels that better match the
levels of problem loans.20

18 The ratio of ALLL-to-total assets in this analysis follows a similar practice found in Luc Laeven and Giovanni
Majnoni, “Loan Loss Provisioning and Economic Slowdowns: Too Much, Too Late?” Journal of Financial
Intermediation
, vol. 12, no. 2 (April 2003), pp. 178-197. Loan loss reserve proceeds, however, must come from current
income earnings as opposed to total assets.
19 See James B. Thomson, “Current Banking Conditions, FDIC-Insured Institutions,” Federal Reserve Bank of
Cleveland, Economic Trends, June 1, 2010, at http://www.clevelandfed.org/research/trends/2010/0610/02banfin.cfm.
20 In addition to responding to higher balance sheet risks, regulators are implementing Basel II.5, Basel III, and the
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act; P.L. 111-203), which
collectively will result in higher bank capital requirements. See CRS Report R42744, U.S. Implementation of the Basel
Capital Regulatory Framework
, by Darryl E. Getter.
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Figure 5. Coverage Ratio
2000-2012
200.0%
ses
180.0%
Lea
160.0%
and
s
n

140.0%
a
o
L

120.0%
nt
re

100.0%
ur
80.0%
onc
N

60.0%
to
LL

40.0%
L
20.0%
io A
Rat

0.0%
0
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1
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Q
Q
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Q
Q
Q
Q
Q
Q
Q
Quarters

Source: FDIC.
As regulators have taken measures to restore ALLL and other components of bank capital to
higher levels, the growth rate of bank lending portfolios is likely to be affected. Similarly, a weak
demand for loans or decline in the number of borrowers deemed creditworthy can also cause
banks to make fewer loans, meaning that asset portfolios would grow at a slower pace.21 The
asset growth rate is computed as the percentage change in total assets from quarter to quarter, and
is shown in Figure 6. The asset growth rate fell below negative 2% beginning in the first quarter
of 2009, which had not occurred since the 1990-1991 recession22, and remained negative until a
year later; 2010 also saw negative asset growth during the second and fourth quarters. Given the
magnitude of loan repayment problems, banks grew more cautious about lending (or growing
their asset portfolios) to avoid the risk of further weakening their ALLL and capital reserve
positions, which are more difficult to keep in regulatory compliance in a distressed environment.
Consequently, although the rate of bank lending has increased since the recession, it has not
returned to pre-recessionary levels despite the industry’s return to profitability.

21 See CRS Report R41623, U.S. Household Debt Reduction, by Darryl E. Getter.
22 See National Bureau of Economic Research Business Cycle Dating Committee, March 1991, at http://www.nber.org/
March91.html.
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Financial Condition of Depository Banks

Figure 6. Asset Growth Rate
1990-2012
Asset Growth Rate (Moving Average)
3.00
2.50
2.00
1.50
1.00
ate
R
th
0.50
w
o
Gr
0.00
-0.50
-1.00
-1.50
-2.00
2
1
4
3
2
1
4
3
2
1
4
3
2
1
4
3
2
1
4
3
2
1
4
3
2
1
4
3
2
1
4
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
90
91
91
92
93
94
94
95
96
97
97
98
99
00
00
01
02
03
03
04
05
06
06
07
08
09
09
10
11
12
12
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
Quarters

Source: FDIC.
Notes: The asset growth rate is shown as a moving average, which was computed by CRS.
Overview of Revenue Composition by Bank Size
As previously stated, banks typically borrow funds from depositors for shorter periods of time
relative to their originated loans. Banks must continuously renew their short-term borrowings
until longer-term loans have been fully repaid. For example, suppose a bank originates a
consumer loan that is expected to be repaid in full over two years. Over the two years that the
loan is being repaid, the bank will simultaneously “fund the loan,” meaning that it will treat its
depositors’ funds as a sequence of quarterly (for a total of eight quarters) or monthly (for a total
of 24 months) short-term loans and make periodic interest payments to depositors.23 The spread
or difference between lending long and borrowing short is known as the net interest margin.
Smaller banks typically engage in “relationship banking,” meaning that they develop close
familiarity with their respective customer bases and typically provide financial services within a
circumscribed geographical area. Relationship banking allows these institutions to capture

23 For example, if a bank originates a two-year loan at a fixed 6% interest rate and pays depositors a 2% return, then the
net interest margin or spread would be 4%. Given that the 6% rate is fixed, fluctuations in short-term interest rates
mean that the spread would also fluctuate over the two years that the loan is being repaid.
Congressional Research Service
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Financial Condition of Depository Banks

lending risks that are unique, infrequent, and localized. These institutions, which rely heavily on
commercial (real estate and retail) lending and funding with deposits, typically have higher net
interest margins than large banks. Funding loans with deposits is cheaper than accessing the
short-term financial markets, particularly for small institutions that do not have the transaction
volume or size to justify the higher costs.
In contrast, large institutions typically engage in “transactional banking” or high-volume lending
that employs automated underwriting methodologies that often cannot capture atypical lending
risks.24 Large banks are not as dependent upon deposits to fund their lending activities given their
greater ability to access short-term money markets. Large banks typically have lower spreads
because their large-scale activities generate large amounts of fee income from a wide range of
activities, which can be used to cover the costs of borrowing in the short-term money markets.25
Revenues are earned by originating and selling large amounts of loans to nonbank institutions,
such as government-sponsored enterprises (Fannie Mae and Freddie Mac) and non-depository
institutions that hold financial assets (e.g., insurance companies, hedge funds). A large share of
fees are still generated from traditional banking activities (e.g., safe deposit, payroll processing,
trust services, payment services) and from facilitating daily purchase and payment transactions, in
which service fees may be collected from checking, money orders, and electronic payment card
(debit and credit) transactions.26 Hence, transactional or high-volume banking activities allow
large banks to generate fee income and engage in financial transactions characterized by
minimum deal size or institutional size requirements, which simultaneously act as a barrier to
participation by community banks.27
Given the differences in the composition of bank revenue streams, the net interest margins and
fee income streams are illustrated by asset size categories. Figure 7 presents the net interest
margins (or spreads) by bank size. By 2009, the net interest margins had declined for small banks,
but they still remained higher over time than the margins for larger banks. The net interest
margins for large banks increased over the recession period as they experienced a large influx of
deposits during the recession, perhaps due to uncertainty in the money market; this “flight to
safety” influx resulted in a substantial drop in their funding costs.28 In other words, large banks

24 For more information on automated underwriting, see Wayne Passmore and Roger Sparks, The Effect of Automated
Underwriting on the Profitability of Mortgage Securitization
, Federal Reserve Board, Finance and Discussion Series
1997-19, Washington, DC, 1997, at http://www.federalreserve.gov/pubs/feds/1997/199719/199719abs.html.
25 See Judy Plock, Mike Anas, and David Van Vickle, “Does Net Interest Margin Matter to Banks?,” Federal Deposit
Insurance Corporation, FDIC Outlook, June 2, 2004, at http://www.fdic.gov/bank/analytical/regional/ro20042q/na/
infocus.html.
26 See CRS Report R41529, Supervision of U.S. Payment, Clearing, and Settlement Systems: Designation of Financial
Market Utilities (FMUs)
, by Marc Labonte.
27 See Conference of State Bank Supervisors, Community Banks and Capital: Assessing a Community Bank’s Need
and Access to Capital in the Face of Market and Regulatory Challenges, December 2011, at http://CSBS-
CommunityBanksCapitalWhitePaper120811.pdf.
28 For more information on the influx of deposits into the banking system, see Paul Davis, “In Cash Glut, Banks Try to
Discourage New Deposits,” American Banker, July 2010, at http://www.americanbanker.com/bulletins/-1023018-
1.html; Office of the Comptroller of the Currency, Semi-Annual Risk Perspective, Spring 2012, at http://occ.gov/
publications/publications-by-type/other-publications-reports/semiannual-risk-perspective/semiannual-risk-perspective-
spring-2012.pdf. Many depositors may have moved money to larger banks in response to uncertainty in the money
markets. For discussions about money market funds falling below $1 per share, see Nada Mora, “Can Banks Provide
Liquidity in a Financial Crisis?,” Economic Review, Federal Reserve Bank of Kansas City, Third Quarter 2010, pp. 31-
68; CRS Report R42083, Financial Stability Oversight Council: A Framework to Mitigate Systemic Risk, by Edward V.
Murphy; and CRS Report R42787, An Overview of the Transaction Account Guarantee (TAG) Program and the
Potential Impact of Its Expiration or Extension
, by Sean M. Hoskins.
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Financial Condition of Depository Banks

were able to rely relatively less on short-term financial markets and could, instead, take advantage
of cheaper funding from deposits. Although net interest margins may appear to be returning to
pre-recession trends, the future performance of this spread would still be affected by any of the
following factors. The spread may be affected by an increase in liquid asset holdings (e.g.,
securities backed by the U.S. federal government), perhaps due to weaker demand for more
illiquid loans (e.g., mortgages, commercial loans) or lower capital requirements associated with
holding more liquid loans. The spread may also be affected by the amount of deposits that remain
or flow out of the banking system as the economy strengthens. Hence, it has become more
challenging to predict future profitability arising from more traditional lending activities.
Figure 7. Net Interest Margins by Bank Size Categories
2002-2012
4.50%
4.30%
4.10%
ead)
pr
3.90%
(S
in
3.70%
rg
a
3.50%
M
est 3.30%
ter 3.10%
t In
e
2.90%
N
2.70%
2.50%
002
003
004
005
006
007
008
009
010
011
012
1 2
1 2
1 2
1 2
1 2
1 2
1 2
1 2
1 2
1 2
1 2
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Quarters
Assets > $10 Billion
Assets $1 Billion - $10 Billion
Assets $100 Mil ion - $1 Billion
Assets < $100 Million
All Insured Institutions

Source: FDIC.
Figure 8 presents non-interest income as a percentage of assets by bank size. As mentioned
earlier, the FDIC reported that non-interest was an important determinant of industry profitability
in 2012. The overall profitability trend of fee generating activities has rebounded since the
recession, but there appears to be more volatility in the fee income revenues of smaller
institutions. Although greater reliance upon fee income as a percentage of (large) bank income
suggests a reduction in exposure to credit and funding risks, it may not necessarily translate into
Congressional Research Service
13

Financial Condition of Depository Banks

greater stability of earnings streams.29 For example, banks no longer collect fees by selling
mortgage loans to the private-label mortgage securitization market, which was largely abandoned
by investors at the beginning of the financial crisis.30 In other words, high-volume fee-generating
transactions are still dependent upon fluctuations in investor demand for securities that are
created from securitized (structured finance) deals, which adds variability to income. In addition,
regulatory costs may reduce fee income. Recent regulation of credit card fees as well as on fees
that large institutions may collect from debit transactions would affect the earnings streams.31
Banks would likely seek new opportunities to provide financial services to generate new fee
revenues. Hence, future fee generating activities are still affected by financial market uncertainty.
Figure 8. Percentage of Non-Interest Income by Bank Size Categories
2002-2012
3.00%
2.50%

of
ge
a

2.00%
1.50%
Percent
a
as

ts
e
1.00%
e
s
As

0.50%
Incom
002
003
004
005
006
007
008
009
010
011
012
1 2
1 2
1 2
1 2
1 2
1 2
1 2
1 2
1 2
1 2
1 2
terest
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
-In
n

Quarters
o
N

Assets > $10 Bil ion
Assets $1 Bil ion - $10 Bil ion
Assets $100 Mil ion - $1 Billion
Assets < $100 Mil ion
All Insured Institutions

Source: FDIC.

29 Robert DeYoung and Tara Rice, “How Do Banks Make Money? The Fallacies of Fee Income,” Federal Reserve
Bank of Chicago, Economic Perspectives, 2004, pp. 34-51, at http://www.chicagofed.org/digital_assets/publications/
economic_perspectives/2004/ep_4qtr2004_part3_DeYoung_Rice.pdf.
30 For information on securitization markets issues, see U.S. Congress, Senate Committee on Banking, Housing, and
Urban Affairs, Subcommittee on Securities, Insurance and Investment, Securitization of Assets: Problems and
Solutions
, Testimony of George P. Miller, American Securitization Forum, 111th Cong., 1st sess., October 7, 2009.
31 See CRS Report RL34393, The Credit Card Market: Recent Trends and Regulatory Actions, by Darryl E. Getter; and
CRS Report R41913, Regulation of Debit Interchange Fees, by Darryl E. Getter.
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Financial Condition of Depository Banks

Conclusion
The banking industry has exhibited signs of improved profitability since the 2007-2009 financial
crisis, but lending has not returned to pre-crisis levels. Bank profitability ratios have returned to
positive territory. Net interest margins and fee income as a percentage of assets are less volatile
now than when the U.S. economy was in recession. The industry, however, still has more non-
current assets relative to ALLL that can absorb potential losses; and there are still many banks on
the FDIC’s problem list. These factors may be influencing the asset growth rate, which has been
positive since 2011, but remains below the average rate of growth observed over the past two
decades.
Profitability in the banking industry is not necessarily evidence of a return to previous lending
patterns given that the industry is adapting its business model under the new regulatory
environment. Lending costs are expected to increase for depository banks as a result of higher
overall capital requirements established by the Basel Committee on Banking Supervisors and by
the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (P.L. 111-203, 124
Stat. 1376).32 Given that large banks are less dependent upon traditional lending activities than
smaller banks, the large institutions may be able to generate enough fee income from a wide
range of other financial activities to remain profitable even if lending activity does not resemble
pre-recessionary levels. Hence, profitability trends may differ for banks by size.

Author Contact Information
Darryl E. Getter
Specialist in Financial Economics
dgetter@crs.loc.gov, 7-2834


32 For more information on the Basel Committee of Banking Supervisors and the Basel III Accord, see
http://www.bis.org/.
Congressional Research Service
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