COVID-19 Impact on the Banking Industry: Conditions in the Second Quarter of 2020

COVID-19 Impact on the Banking Industry: Conditions in the Second Quarter of 2020

INSIGHTi
COVID-19 Impact on the Banking Industry:
Conditions in the Second Quarter of 2020
September 10, 2020
The economic ramifications of the Coronavirus Disease 2019 (COVID-19) pandemic could cause
borrowers to miss loan payments, potential y to the point of individual banks or the bank industry
becoming distressed. How and to what degree banks wil be affected is uncertain. Comprehensive bank
data are collected and released quarterly and provide indicators of industry health. On August 25, 2020,
the Federal Deposit Insurance Corporation (FDIC) released the Quarterly Banking Profile: Second
Quarter 2020, which reports aggregate data from al 5,066 FDIC-insured institutions as of June 30, 2020.
This Insight presents certain data that may indicate how the pandemic is affecting banks.
Background
The COVID-19 pandemic has caused mil ions of businesses to close or limit operations and cost tens of
mil ions of people their jobs. Economic downturns can threaten banks because more businesses and
households may miss loan repayments. Because most bank assets are these types of loans, the missed
payments can reduce bank income and impose significant losses. Meanwhile, bank liabilities—the
deposits they hold and the debt they owe—obligate banks to make funds available to depositors and
creditors. If borrower repayments were to decline enough, a bank’s ability to meet those obligations could
become impaired, potential y causing it to fail. In contrast, bank capital—largely equity stock and
retained profits from earlier periods—enables a bank to absorb a certain amount of losses without failing.
For this reason, bank regulators require banks hold certain amounts of capital (in addition to subjecting
them to a variety of safety and soundness regulations) in order to avoid failures. If losses were sufficiently
large, banks may nevertheless fail, reducing credit available to the economy and potential y destabilizing
the financial system.
Certain effects and bank responses to economic downturns—such as reduced income and increased loan
loss reserves (described below)—occur shortly after the onset of economic deterioration. Other effects—
such as increased loan delinquency, incurred losses on assets, and reduced capital value—occur after a
longer lag.
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CRS INSIGHT
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Income and Loss Reserves
In the second quarter of 2020, banking industry net income (i.e., profits) was $18.8 bil ion, a decline of
nearly 70% from the $62.5 bil ion in the second quarter of 2019. This follows a similar decline in first
quarter 2020 income.
In addition, banks increased the amount of credit loss reserves to absorb anticipated losses. (Credit loss
reserves offset the overstatement of income on loans and other assets by adjusting for potential future
losses on related loans and other assets.)
Before this Insight assesses the size of credit loss reserves, it notes an ongoing change in accounting
method. In response to banks’ financial chal enges resulting from the 2007-2009 financial crisis, the
Financial Accounting Standards Board (FASB) promulgated a new credit loss standard—Current
Expected Credit Loss (CECL)—in June 2016, and requirements to use the new standard have recently
started to apply to certain banks. CECL requires earlier recognition of losses compared with the
methodology it is replacing. Supporters of the new standard assert reserving for losses earlier would
reduce the impact of downturns. Other observers assert the standard is excessively cautious, as a bank
must reserve for al losses expected over the entire life of the loan when it first makes the loan.
Large publicly traded companies (including publicly traded banks) were required to issue financial
statements that incorporated CECL for reporting periods beginning December 15, 2019. However, the
March 2020 CARES Act mandated that no bank shal be required to use CECL methodology from the
date of enactment until the earlier of (1) the date the public health emergency ends or (2) the end of 2020.
Bank regulators gave banks the option to delay the use of CECL for two years followed by a three-year
transition period. For more information on CECL, see CRS Report R45339, Banking: Current Expected
Credit Loss (CECL), by Raj Gnanarajah.
Total provision for bank credit loss reserves was $61.9 bil ion, an increase of nearly $41.9 bil ion (or
382%) from $12.8 bil ion at the end of the second quarter of 2019. The 253 banks that used CECL
methodology reported $56 bil ion in provision for credit loss reserves, and non-CECL adopters reported
approximately $6 bil ion. This size disparity is due in large part to the fact that publicly traded banks tend
to be much larger relative to other banks. Nevertheless, the disparity could raise concerns. If banks using
the older methodology, which does not require losses to be recognized as quickly, do not make sufficient
credit loss reserves to absorb the losses, then some of those banks might (1) need to consider
consolidating with healthier banks, or (2) face failure.
Table 1. Income and Loss Reserves

Second Quarter of 2020
Second Quarter of 2019
Net Income
$18.8 bil ion
$62.5 bil ion
Credit Loss Reserves
$61.9 bil ion
$12.8 bil ion
Source: FDIC, Quarterly Banking Profile: Second Quarter 2020.
Loan Performance and Capital
Two indicators of bank health that deteriorate after a time lag are loan performance and capital levels, and
these have yet to be significantly affected by the pandemic.
The most recent data showed an uptick of loan nonperformance and loan charge-offs (what happens when
a bank gives up on a loan and writes off the loan’s reported value from bank assets). However, the levels
of these indicators have not reached unusual y high levels. As of June 30, 2020, the noncurrent rate (i.e.,

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percent of loans more than 90 days past due or in nonaccrual status) rose to 1.08%, up from 0.93% a year
earlier. For context, in the aftermath of the 2007-2009 financial crisis, the rate reached a peak of 5.46% in
the first quarter of 2010. The second quarter net charge-off rate was 0.57%, up from 0.50% a year ago.
This rate had a recent peak of 3.00% in the fourth quarter of 2009.
Regarding capital, banks added $31.9 bil ion in bank equity capital in the second quarter, a 1.51%
quarterly increase. This growth rate is down from a year ago, when banks added $38.6 bil ion in the
second quarter—a 1.95% increase—but indicates the downturn has not yet hurt bank capital. In contrast,
in the last crisis, bank equity capital decreased by $44.9 bil ion (3.3%) in the third quarter of 2008.
Table 2. Loan Performance and Bank Equity Capital

Second Quarter of 2020
Second Quarter of 2019
Noncurrent Rate
1.08%
0.93%
Net Charge-Off Rate
0.57%
0.50%
Bank Equity Capital Change
$31.9 bil ion, or 1.51%
$38.6 bil ion, or 1.95%
Source: FDIC, Quarterly Banking Profile: Second Quarter 2020.

Author Information

David W. Perkins
Raj Gnanarajah
Specialist in Macroeconomic Policy
Analyst in Financial Economics

Disclaimer
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