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

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

INSIGHTi
COVID-19 Impact on the Banking Industry:
Conditions in the Third Quarter of 2020
December 23, 2020
The economic ramifications of the Coronavirus Disease 2019 (COVID-19) pandemic could include
borrowers missing loan payments, potential y causing distress for banks. Bank regulators release
comprehensive data on bank condition and income every quarter. On December 1, 2020, the Federal
Deposit Insurance Corporation (FDIC) released the Quarterly Banking Profile: Third Quarter 2020,
which reports aggregate data from al 5,033 FDIC-insured institutions as of September 30, 2020. This
Insight presents certain statistics about how the pandemic is affecting banks.
Background
The pandemic has caused businesses to close or limit operations and mil ions of job losses. Economic
downturns threaten bank profitability because more borrowers might miss loan repayments, which can
reduce bank income and impose 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
decline enough, a bank’s ability to meet its 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. However, if losses are sufficiently large, banks may nevertheless
fail, reducing credit available to the economy and potential y destabilizing the financial system.
Certain effects of, and bank responses to, economic downturns—such as reduced income and increased
credit loss reserves—occur shortly after the onset of economic deterioration. Other effects—such as
increased loan delinquency, incurred losses, and reduced capital value—occur after a longer lag (see CRS
Insight IN11501, COVID-19 Impact on the Banking Industry: Lag Between Recession and Bank Distress).
Thus far the bank industry is holding up wel , but as the pandemic continues to affect the economy, signs
of stress may start to emerge.
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IN11562
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Income and Loss Reserves
In the third quarter of 2020, banking industry profits were $51.2 bil ion, a decline of nearly 11% from the
$57.4 bil ion in the third quarter of 2019 but an increase from second quarter 2020 profits of $18.8 bil ion.
Profits rose in part because of a decline in provisions for credit losses from the second quarter, when
credit loss reserves spiked. Credit loss reserves were $14.4 bil ion in the third quarter of 2020 and $61.9
bil ion in the second (see Error! Reference source not found.). The spike and subsequent decline could
be a response to the pandemic, a change to accounting methodology, or both.
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. In June 2016, the Financial Accounting Standards Board
promulgated a new credit loss standard—Current Expected Credit Loss (CECL)—which requires earlier
recognition of losses. Large publicly traded companies (including publicly traded banks) were required to
issue financial statements that incorporated CECL for reporting periods beginning December 15, 2019.
Although the CARES Act mandated that regulators cannot require banks to use CECL until the earlier of
the end of the public health emergency or the end of 2020 (and the bank regulators gave banks the option
to delay the use of CECL for two years followed by a three-year transition period), 254 banks
nevertheless made the transition by the third quarter. Reportedly, most of the largest banks that
collectively hold nearly 80% of the industry’s assets are among those that made the transition. This makes
it difficult to determine to what extent the recent changes in loss reserve statistics are the result of the
pandemic. For more information on CECL, see CRS Report R45339, Banking: Current Expected Credit
Loss (CECL).
Table 1. Income and Loss Reserves

3rd quarter 2020
2nd quarter 2020
3rd quarter 2019
Net income
$51.2 bil ion
$18.8 bil ion
$57.4 bil ion
Credit loss reserves
$14.4 bil ion
$61.9 bil ion
$13.9 bil ion
Source: FDIC, Quarterly Banking Profile: Third 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 the noncurrent loan rate, although the level has not reached
unusual y high levels (see Error! Reference source not found.). The third quarter noncurrent rate (i.e.,
percent of loans more than 90 days past due or in nonaccrual status) rose to 1.17%, up from 0.92% 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. As part of the exception al owed under the CARES Act, banks are not yet
reporting loans that are in forbearance as noncurrent, however.
Loan charge-offs (what happens when a bank gives up on a loan and writes off the loan’s reported value
from bank assets) ticked down from the second quarter and a year ago. The third quarter net charge-off
rate was 0.46%, down from 0.51% a year ago. This rate had a recent peak of 3.00% in the fourth quarter
of 2009.
Regarding capital, banks added $36.3 bil ion in bank equity capital, a 1.7% quarterly increase. This
growth rate is up from a year ago, when banks added $3.5 bil ion in the third quarter, a 0.2% increase. (In
the last crisis, bank equity capital decreased by $44.9 bil ion, or 3.3%, in the third quarter of 2008.) The

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increase in capital was almost entirely due to retained earnings—that is, profits that were not distributed
to shareholders as dividends—which were 270% greater than a year earlier. This may be due, at least in
part, to regulator limits on capital distributions imposed during the pandemic. It may also indicate that
banks are building up their capital reserves to be flexible to respond to future adverse conditions.
Table 2. Loan Performance and Capital

3rd quarter 2020
2nd quarter 2020
3rd quarter 2019
Noncurrent rate
1.17%
1.08%
0.92%
Net charge-off rate
0.46%
0.57%
0.51%
Bank equity capital (BEC)
$2,185.8 bil ion
$2,149.5 bil ion
$2,101.4 bil ion
BEC quarterly change
$36.3 bil ion, or 1.7%
$31.9 bil ion, or 1.5%
$3.5 bil ion, or 0.2%
Source: FDIC, Quarterly Banking Profile: Third Quarter 2020.
The number of banks on the FDIC’s “Problem Bank” list may also indicate that the industry has yet to
experience widespread stress, as recent quarters have seen a slight uptick to 56 banks in the third quarter
from 51 at the end of 2019.

Author Information

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

Disclaimer
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