COVID-19 Impact on the Banking Industry: Conditions at the End of 2020

COVID-19 Impact on the Banking Industry: Conditions at the End of 2020

INSIGHTi
COVID-19 Impact on the Banking Industry:
Conditions at the End of 2020
March 17, 2021
Although bank regulation is designed to al ow banks to withstand some amount of unexpected losses, the
economic ramifications of the Coronavirus Disease 2019 (COVID-19) pandemic could result in enough
borrowers missing loan payments to cause distress for banks. The Federal Deposit Insurance Corporation
(FDIC) releases comprehensive data on bank condition and income quarterly, and it recently released the
Quarterly Banking Profile: Fourth Quarter 2020, which reports aggregate data from al 5,001 FDIC-
insured institutions as of December 31, 2020. This Insight presents certain bank industry statistics as of
the end of 2020 and examines how the pandemic might be affecting the industry.
Background
Economic downturns threaten bank profitability, reduce bank income, and impose losses as borrowers
miss repayments. 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 to 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 appears to be holding up wel , but as the pandemic continues to affect the
economy, signs of stress may start to emerge.
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Income and Loss Reserves
Full-year 2020 profit for the banking industry was $147.9 bil ion, a 36.5% decrease from 2019 (see
Error! Reference source not found.). The full-year decline came mostly from banks increasing credit
loss reserves in the first half of the year—possibly in response to the pandemic’s effects on the
economy—accounting for $132.2 bil ion in expenses in 2020, a 140% increase from 2019. In addition,
net interest income declined by $20.0 bil ion (or 3.7%) as the average net interest margin (the difference
between the interest rates banks earn and pay out) declined to 2.82% from 3.36%.
Credit loss reserves adjust income on loans and other assets by accounting for potential future losses on
those loans and 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 (P.L. 116-136) 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), 279 banks
nevertheless made the transition by the fourth 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. Bank Income and Credit Loss Reserve Expenses

2020
2019
Annual change
Net income
$147.9 bil ion
$233.1 bil ion
-36.5%
Credit loss reserve
$132.2 bil ion
$55.1 bil ion
140.0%
expenses
Source: FDIC, Quarterly Banking Profile: Fourth Quarter 2020.
Loan Performance and Capital
Loan performance and capital levels—two indicators that deteriorate after a time lag—have yet to be
significantly affected by the pandemic.
The noncurrent loan rate (i.e., percent of loans more than 90 days past due or in nonaccrual status) rose
during the year, although the level is not unusual y high. However, as part of an exception al owed under
the CARES Act, banks are not yet reporting loans that are in forbearance as noncurrent. The fourth
quarter noncurrent rate was 1.18%, up from 0.91% a year earlier (see Error! Reference source not
found.). For context, after the 2007-2009 financial crisis, the rate peaked at 5.46% in the first quarter of
2010.
Loan charge-offs (when a bank gives up on a loan and writes off the loan’s reported value from its assets)
ticked down from the third quarter and a year ago. The net charge-off rate was 0.41%, down from 0.54%
a year earlier. The post-financial crisis rate peaked at 3.00% in the fourth quarter of 2009.
Banks added $41.9 bil ion in bank equity capital in the fourth quarter of 2020, a 1.9% quarterly increase,
up from a year ago when banks added $12.8 bil ion, a 0.6% quarterly increase. (In the last crisis, bank
equity capital decreased by $44.9 bil ion, or 3.3%, in the third quarter of 2008.) The increase in capital

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was almost entirely due to retained earnings—that is, profits that were not distributed to shareholders as
dividends—which were 571% greater in the fourth quarter than a year earlier. This may be due, at least in

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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

4th quarter 2020
3rd quarter 2020
4th quarter 2019
Noncurrent rate
1.18%
1.17%
0.91%
Net charge-off rate
0.41%
0.46%
0.54%
Bank equity capital
$2,225 bil ion
$2,183 bil ion
$2,111 bil ion
(BEC)
BEC quarterly change
$41.9 bil ion, or 1.9%
$36.3 bil ion, or 1.7%
$12.8 bil ion, or 0.6%
Source: FDIC, Quarterly Banking Profile: Fourth Quarter 2020.
The number of banks on the FDIC’s “Problem Bank” list may also indicate the industry has yet to
experience widespread stress, as that number rose slightly during the year to 56 at the end of 2020 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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