COVID-19 Impact on the Banking Industry: Lag Between Recession and Bank Distress
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INSIGHTi
COVID-19 Impact on the Banking Industry:
Lag Between Recession and Bank Distress
September 10, 2020
Economic recessions and financial crises can cause distress in the banking industry. Typically, there is a
lag between the onset of a recession and the peak of bank industry distress. The economic effects of the
Coronavirus Disease 2019 (COVID-19) pandemic could similarly stress the banking industry, perhaps
acutely, given the sudden and unprecedented nature of the economic contraction. Even though this
contraction is severe, a lag is expected, and certain provisions in the Coronavirus Aid, Relief, and
Economic Recovery Act (CARES Act; P.L. 116-136) may lengthen it.
Typical Lags
When people lose jobs or businesses revenue declines, many individuals and businesses have resources to
continue making loan payments for a time. For example, U.S. households and nonprofit organizations
held almost $11.4 trillion in cash and bank accounts and another $2.6 trillion in money market mutual
funds (an instrument similar to a bank account) at the end of 2019. U.S. nonfinancial businesses held
almost $3.5 trillion in cash and bank accounts and $808 billion in money market mutual funds. In
addition, individuals who lose jobs are often eligible for unemployment benefits. Reducing expenses and
drawing on lines of credit (e.g., credit cards) to meet those expenses are other strategies that could allow
borrowers to continue to make installment loan (e.g., mortgage) payments.
These resources can last for a time, but missed loan payments begin to grow at some point. Even then,
banks have some time before they become distressed as a consequence. If a borrower were to miss a few
payments, it would not necessarily mean the loan is a total loss. The borrower might find a new job, or
business might start to pick back up. For this reason, a loan goes through a progression of statuses in bank
records—30-89 days late, 90+ days late, nonaccrual—before the bank writes it off as a loss (called a
charge-off). The bank tries to recover what value it can, such as through a foreclosure and sale of a
property securing a mortgage. The net charge-off is the amount that is ultimately unrecoverable. Once
losses start to accumulate, a bank may deplete its capital to a point that it is seriously impaired and in
danger of failing. Bank capital can be considered the owner’s investment in a bank, which includes the
investment by the stockholders of bank stock, and an instrument that enables a bank to absorb losses on
assets. As shown in Figure 1, in the last three recessions, the two-year cumulative net charge-off rate does
not peak until one to three years after the onset of a recession.
Congressional Research Service
https://crsreports.congress.gov
IN11501
CRS INSIGHT
Prepared for Members and
Committees of Congress
Congressional Research Service
2
Figure 1. Two-Year Cumulative Net Charge-Off Loss Rate, as % of Average Total Assets
Sources: FDIC, Quarterly Banking Profile: Second Quarter 2020, at https://www.fdic.gov/bank/analytical/qbp/; CRS
calculations.
Note: Two-year cumulative net charge-off rate is the sum of the most recent eight quarters of net charge-offs divided by
average total assets over that period.
Given these factors, it is not surprising that the most recently available bank data does not yet show
signals of bank distress.
Potential CARES Act Effects
Certain CARES Act provisions provide funds to individuals and businesses and thus may improve their
abilities to make loan payments. In addition, the CARES Act may affect how loans with missed payments
progress from current to noncurrent to written off. (CARES Act provisions and regulator actions that
provide regulatory relief to banks, as well as Federal Reserve programs that provide liquidity and support
the macroeconomy, are beyond the scope of this Insight.)
Three large programs that provide such direct support to individuals and businesses are the Paycheck
Protection Program (PPP), Economic Impact Payments (EIP), and the expansion of unemployment
insurance (UI) payments. Details about eligibility criteria and other program features are available in the
links in the previous sentence. Regarding the amount of funding these programs have provided,
over 5.2 million PPP loans totaling $525 billion in value had been approved for
businesses by the time the program expired on August 8, 2020;
Congressional Research Service
3
nearly 160 million EIPs totaling approximately $270 billion had been disbursed to
eligible households by June 30, 2020; and
people receiving UI payments received an extra $600 per week until July 31, 2020, and
these payments reportedly totaled $250 billion (some states have made additional UI
benefits available after July 31, pursuant to an executive order issued by the President on
August 8).
Another CARES Act provision requires that certain mortgage servicers grant, upon request from the
borrower, a forbearance (i.e., permission to postpone payments) on certain home mortgages. Payments
can be postponed for up to six months in the initial forbearance, and this can extended an additional six
months. Banks own many of the mortgages eligible for forbearance and may face challenges in
accounting for nonperforming loans. As of August 10, the number of mortgages in forbearance stands
around 7.5%, according to one company tracking the industry. Further, numerous borrowers may exit the
CARES Act forbearance period in a similar economic position in which they entered it. For example,
extended forbearances outnumbered resolved forbearances two-to-one in July, suggesting a sizeable
number of consumers are still struggling to make payments.
One particular concern centers on foreclosure. In normal times, when a mortgage falls 120 days
behind, foreclosure proceedings can begin. (Federal law prohibits foreclosures until after a
borrower has become 120 days delinquent.) From a bank’s perspective, foreclosure is a process
by which it can repossess a property where the borrower can no longer make payments and
recover value from a nonperforming loan. During a forbearance, a borrower’s status is paused;
however, as the CARES Act forbearances start to expire over the next 6-12 months, mortgage
servicers may be in a position of servicing a number of loans that have not been able to make
payments for several months for up to 120 more days. If the concentration of borrowers exiting
forbearance who are unable to continue making payments were to become significant, then banks
may be facing conditions that would not be realized for several months, which could portend an
increase in foreclosures.
Author Information
Andrew P. Scott
David W. Perkins
Analyst in Financial Economics
Specialist in Macroeconomic Policy
Disclaimer
This document was prepared by the Congressional Research Service (CRS). CRS serves as nonpartisan shared staff
to congressional committees and Members of Congress. It operates solely at the behest of and under the direction of
Congress. Information in a CRS Report should not be relied upon for purposes other than public understanding of
information that has been provided by CRS to Members of Congress in connection with CRS’s institutional role.
CRS Reports, as a work of the United States Government, are not subject to copyright protection in the United
States. Any CRS Report may be reproduced and distributed in its entirety without permission from CRS. However,
as a CRS Report may include copyrighted images or material from a third party, you may need to obtain the
permission of the copyright holder if you wish to copy or otherwise use copyrighted material.
Congressional Research Service
4
IN11501 · VERSION 7 · NEW
INSIGHTi
COVID-19 Impact on the Banking Industry:
Lag Between Recession and Bank Distress
September 10, 2020
Economic recessions and financial crises can cause distress in the banking industry. Typically, there is a
lag between the onset of a recession and the peak of bank industry distress. The economic effects of the
Coronavirus Disease 2019 (COVID-19) pandemic could similarly stress the banking industry, perhaps
acutely, given the sudden and unprecedented nature of the economic contraction. Even though this
contraction is severe, a lag is expected, and certain provisions in the Coronavirus Aid, Relief, and
Economic Recovery Act (CARES Act; P.L. 116-136) may lengthen it.
Typical Lags
When people lose jobs or businesses revenue declines, many individuals and businesses have resources to
continue making loan payments for a time. For example, U.S. households and nonprofit organizations
held almost $11.4 trillion in cash and bank accounts and another $2.6 trillion in money market mutual
funds (an instrument similar to a bank account) at the end of 2019. U.S. nonfinancial businesses held
almost $3.5 trillion in cash and bank accounts and $808 billion in money market mutual funds. In
addition, individuals who lose jobs are often eligible for unemployment benefits. Reducing expenses and
drawing on lines of credit (e.g., credit cards) to meet those expenses are other strategies that could allow
borrowers to continue to make installment loan (e.g., mortgage) payments.
These resources can last for a time, but missed loan payments begin to grow at some point. Even then,
banks have some time before they become distressed as a consequence. If a borrower were to miss a few
payments, it would not necessarily mean the loan is a total loss. The borrower might find a new job, or
business might start to pick back up. For this reason, a loan goes through a progression of statuses in bank
records—30-89 days late, 90+ days late, nonaccrual—before the bank writes it off as a loss (called a
charge-off). The bank tries to recover what value it can, such as through a foreclosure and sale of a
property securing a mortgage. The net charge-off is the amount that is ultimately unrecoverable. Once
losses start to accumulate, a bank may deplete its capital to a point that it is seriously impaired and in
danger of failing. Bank capital can be considered the owner’s investment in a bank, which includes the
investment by the stockholders of bank stock, and an instrument that enables a bank to absorb losses on
assets. As shown in Figure 1, in the last three recessions, the two-year cumulative net charge-off rate does
not peak until one to three years after the onset of a recession.
Congressional Research Service
https://crsreports.congress.gov
IN11501
CRS INSIGHT
Prepared for Members and
Committees of Congress
Congressional Research Service
2
Figure 1. Two-Year Cumulative Net Charge-Off Loss Rate, as % of Average Total Assets
Sources: FDIC, Quarterly Banking Profile: Second Quarter 2020, at https://www.fdic.gov/bank/analytical/qbp/; CRS
calculations.
Note: Two-year cumulative net charge-off rate is the sum of the most recent eight quarters of net charge-offs divided by
average total assets over that period.
Given these factors, it is not surprising that the most recently available bank data does not yet show
signals of bank distress.
Potential CARES Act Effects
Certain CARES Act provisions provide funds to individuals and businesses and thus may improve their
abilities to make loan payments. In addition, the CARES Act may affect how loans with missed payments
progress from current to noncurrent to written off. (CARES Act provisions and regulator actions that
provide regulatory relief to banks, as well as Federal Reserve programs that provide liquidity and support
the macroeconomy, are beyond the scope of this Insight.)
Three large programs that provide such direct support to individuals and businesses are the Paycheck
Protection Program (PPP), Economic Impact Payments (EIP), and the expansion of unemployment
insurance (UI) payments. Details about eligibility criteria and other program features are available in the
links in the previous sentence. Regarding the amount of funding these programs have provided,
over 5.2 million PPP loans totaling $525 billion in value had been approved for
businesses by the time the program expired on August 8, 2020;
Congressional Research Service
3
nearly 160 million EIPs totaling approximately $270 billion had been disbursed to
eligible households by June 30, 2020; and
people receiving UI payments received an extra $600 per week until July 31, 2020, and
these payments reportedly totaled $250 billion (some states have made additional UI
benefits available after July 31, pursuant to an executive order issued by the President on
August 8).
Another CARES Act provision requires that certain mortgage servicers grant, upon request from the
borrower, a forbearance (i.e., permission to postpone payments) on certain home mortgages. Payments
can be postponed for up to six months in the initial forbearance, and this can extended an additional six
months. Banks own many of the mortgages eligible for forbearance and may face challenges in
accounting for nonperforming loans. As of August 10, the number of mortgages in forbearance stands
around 7.5%, according to one company tracking the industry. Further, numerous borrowers may exit the
CARES Act forbearance period in a similar economic position in which they entered it. For example,
extended forbearances outnumbered resolved forbearances two-to-one in July, suggesting a sizeable
number of consumers are still struggling to make payments.
One particular concern centers on foreclosure. In normal times, when a mortgage falls 120 days
behind, foreclosure proceedings can begin. (Federal law prohibits foreclosures until after a
borrower has become 120 days delinquent.) From a bank’s perspective, foreclosure is a process
by which it can repossess a property where the borrower can no longer make payments and
recover value from a nonperforming loan. During a forbearance, a borrower’s status is paused;
however, as the CARES Act forbearances start to expire over the next 6-12 months, mortgage
servicers may be in a position of servicing a number of loans that have not been able to make
payments for several months for up to 120 more days. If the concentration of borrowers exiting
forbearance who are unable to continue making payments were to become significant, then banks
may be facing conditions that would not be realized for several months, which could portend an
increase in foreclosures.
Author Information
Andrew P. Scott
David W. Perkins
Analyst in Financial Economics
Specialist in Macroeconomic Policy
Disclaimer
This document was prepared by the Congressional Research Service (CRS). CRS serves as nonpartisan shared staff
to congressional committees and Members of Congress. It operates solely at the behest of and under the direction of
Congress. Information in a CRS Report should not be relied upon for purposes other than public understanding of
information that has been provided by CRS to Members of Congress in connection with CRS’s institutional role.
CRS Reports, as a work of the United States Government, are not subject to copyright protection in the United
States. Any CRS Report may be reproduced and distributed in its entirety without permission from CRS. However,
as a CRS Report may include copyrighted images or material from a third party, you may need to obtain the
permission of the copyright holder if you wish to copy or otherwise use copyrighted material.
Congressional Research Service
4
IN11501 · VERSION 7 · NEW