US Banks Safer But Still "Too Big To Fail"

One of the strongest reminders of the depths of the financial crisis has been the number of US bank failures.  As the chart shows, in 2009 over 140 banks failed and by 2010 the number had risen to 157. For the current year, the Federal Deposit Insurance Corporation (FDIC) is expecting that about 50 to 60 US banks are expected to fail. 

As the economy in the US emerges to a path of stability, job creation and rising consumer and business borrowing has helped the banking industry begin to become profitable again. In the first quarter of 2012, the industry earned about $35 billion, which is up from $29 billion earned in the same period of 2011. This was the best level of industry earnings since 2007.

How did these bank profits come about? As interest rates have fallen to record lows, banks have had to pay nearly zero interest rates for bank deposits made by their customers.  However, banks have still had the ability to loan out these low-cost deposits at higher longer term rates which resulted in expanding profits.  Another plank in their profitability has been from the reduction in having to write off loans. In other words, default rates have dropped and any money banks set aside to cover loan losses that did not emerge are added back to profits.  US banks have come a long way from the financial crisis when the net interest margin (the profit from lending out deposits at higher rates) for all US banks had fallen to the lowest level since the early 1980s.

One of the great ironies of the new banking landscape in the US is that the big banks have gotten bigger. During and after the crisis, regulators worried about banks that had gotten "too big to fail". The five largest financial institutions hold about $8.5 trillion dollars in assets which is equivalent to about 55% of US GDP (the US economy).  Just prior to the financial crisis, their assets were actually a smaller proportion equivalent to approximately 40% of the US economy. 

The US mortgage market provides further evidence of how skewed things have become. Currently, Wells Fargo controls about one-third of all US home lending.  This has regulators concerned but they are faced with a double edged sword as they do not want to do anything to upset the budding recovery in the US real estate sector.

For US policy makers, stabilizing the banking sector was a significant priority. That mission seems to have been accomplished. The next challenge will be regulatory reform and trying to figure out a "Plan B" for the dangers of financial institutions that are even more "too big to fail".

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