Too Good to Be True? Reflecting on the Condition of the U.S. Banking System

There has been increasing interest in the Asian continent regarding the U.S. banking system. Recently I was interviewed by a reporter for The Asian Banker (no relation to Bank Director magazine or the American Banker) about the state of this nation’s banking industry, which gave me some time to reflect on just how far we’ve comeu00e2u20ac”and what we have to conquer ahead.

I was first asked to evaluate the current condition of the U.S. banking system. This was a pleasure, as we are currently experiencing some of the most favorable conditions we’ve seen in years, including low rates, a relatively steep yield curve, and high investor interest. The impact on the nation’s banks has been remarkable, as we now have record capital; record profits; a record number of total assets (10 trillion); the lowest number of problem banks; and the lowest percentage of nonperforming loans (NPLs). Given this scenario, one might be tempted to say the U.S. banking system looks so strong, it’s almost too good to be true.

However, given the cyclical nature of economics, I was asked whether I thought the problems of the 1980s and 1990s were likely to emerge again. For several reasons, I responded, it is unlikely the problems of the 1980s will be reappear in the next economy. Why?

For one thing, bank construction lending activity is much lower than it was 20 years ago. This was the genesis of a great deal of commercial lending deterioration in bank’s assets portfolios.

Also, today adjustable rate mortgages are available so banks can’t get locked into a losing proposition when inflation raises their cost of funds. Hard to believe today, but adjustable rate mortgages were illegal in the 1970s.
There is little to no inflation squeeze of profits like that seen in the 1980s when so many savings and loans were struggling to stay afloat.

And finally, and probably most important, today the quality of leadership and staffing at U.S. banks has risen dramatically. Bank directors and CEOs learned many tough lessons the hard way in the 1980s and 1990s, but the result has been improved management across the board in all areas.

In summary, the principal conditions that caused almost 2,000 banks and S&Ls to fail two decades ago do not appear to be present today. Nor are they likely to re-emerge tomorrow.

So, they asked, “Things can’t be perfect. What worries you and the U.S. banking regulators today?” I responded with the following:

Monster banksu00e2u20ac”These include Citigroup, J.P. Morgan Chase, Miszho, and others. These institutions are extremely difficult to supervise and nearly impossible to take over if they fail because of their business complexity and scale.
Home equity lendingu00e2u20ac”This is the fastest-growing item on banks’ balance sheets). Such loans put the borrower at risk of losing his home if he can’t repay, yet we are seeing more of a trend to refinance credit-card debt with home equity loans, which drastically increases the risk of bankruptcy for consumers.

Derivativesu00e2u20ac”Huge amounts of these alternative instruments are concentrated in our largest banks. However, they are untested in a real economic downturn. One real concern: Fannie Mae and Freddie Mac are substantial users of derivatives and their securities represent large investments by banks.

Consumer savingsu00e2u20ac”The current low consumer saving rates will provide little cushion if or when a slowdown in the economy occurs over an extended period of time.

The current “good” conditions themselvesu00e2u20ac”I’ve seen this over and over again: Bad loans are made in good times. Bank leadership should never get complacent even though the current tide is high.

All in all, we are enjoying an unprecedented run of high performance for the U.S. banking industry. We’ve learned a lot from past mistakes, both community and large banks are standing up to national and global market competition, and directors understand their responsibilities and duties better than ever before. As long as we keep our eyes open and our ethics high, banking’s past will not become prologue.

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