Thanks to over a decade of Dodd-Frank and Basel III regulations, the Trump administration inherits a well-capitalized and liquid banking system. Squandering this gift would be very dangerous to the financial and mental health of Americans. Healthy banks are critical to the U.S. economy more than any other sector.
Bank supervisors globally have a framework to assess banks’ capital, asset quality, management, earnings, liquidity and sensitivity to market risk (CAMELS). A few highlights below show that presently, the American banking system would earn a high CAMELS score. This score is due to the safeguards that bank regulations have required bank executives and senior management to follow since the 2007-2009 financial crisis. Without these regulations, American banks and the U.S. economy would be nowhere as strong as they are now.
Capital
American banks are well-capitalized, which means that collectively they can sustain unexpected losses. According to the Federal Deposit Insurance Corporation, equity capital, which is the most loss sustaining type of capital. rose 3.5% in the third quarter of 2024 to $81.6 billion. In its semiannual Supervision and Regulation Report, the Federal Reserve Board found that 99% of U.S banks are well capitalized. This is a significant improvement from 2020.
Asset Quality
Asset quality remains healthy; loans that are 30 or more days past due or in nonaccrual status are significantly less than they were before the pandemic. The FDIC refers to these loans as past-due and nonaccrual (PDNA); the current PDNA ratio is about 1.5 percent, which is below the average of 1.94 percent before the pandemic. Additionally, banks’ allowance for potential credit losses is still higher than it was during the period before the pandemic.
Earnings
Bank earnings continue to break records. In the last available reporting period, banks earned $65.4 billion. These earnings are significantly higher, despite higher compliance costs being incurred because of new regulations implemented starting in 2010 after the 2007-2009 financial crisis.
Liquidity
Bank failures in the spring of 2023 have certainly encouraged bank executives and senior management to pay attention to banks’ ability to have enough stable funding sources and assets that can be quickly converted to cash. Throughout 2024, the percentage of liquid assets as a percentage of all assets has remained significantly higher than before the pandemic.
Sensitivity to Market Risk
Lower interest rates are especially helping banks with trading books. According to the FDIC, “total unrealized losses of $364.0 billion decreased $148.9 billion (29.0 percent) from the prior quarter. This is the lowest level of unrealized losses for the industry since the first quarter of 2022. Longer-term interest rates such as the 30-year mortgage rate and the 10-year Treasury rate declined significantly during the quarter, increasing the value of securities reported by banks and reducing unrealized losses.” In 2023, higher rates hurt banks with weak interest rate risk management such as Silicon Valley Bank (SVB).
Risks Abound In the Near Term
Unfortunately, the biggest risk on the horizon is in the Trump administration not only in deregulating banks but also in weakening bank supervision. Even before Trump was elected, bank lobbyists had successfully derailed the final proposal on the updated Basel III rules, the so-called End Game. Those important capital, credit, and liquidity rules will not see the light of day for the next four years or even longer.
Bank supervision is comprised of both off-site supervisory exercises such as capital and liquidity stress tests, as well as important on-site bank exams. Not only will the incoming administration make sure that bank rules are weaker, but also legislators will significantly influence the tone at the top of the national bank regulators, the Federal Reserve, FDIC, and OCC. During Trump’s first term, legislators successfully changed capital and liquidity stress testing and reporting requirements for banks the size of Silicon Valley Bank, Signature Bank and First Republic. Even before the Economic Growth, Regulatory Relief, and Consumer Protection Act (S-2155) was signed, I argued that this law was a terrible idea. And it gave me no pleasure to tell Senators in May 2023 as well as House members in September 2023 that unfortunately, I was right. Without strong regulations and good regulatory oversight, bankers will always put profits over the safety and soundness of the banking system, not to mention the protection of American taxpayers.
While I wrote above that asset quality is presently healthy. There are some warnings that legislators and regulators need to pay attention to seriously. In the credit area, while commercial loan defaults are below historic levels, consumer defaults have been rising.
Data from the FDIC shows that the PDNA rate increased 6 basis points from the prior quarter to 1.54 percent. Of concerns is that “the industry’s credit card, multifamily, CRE, and auto loan PDNA rates increased quarter over quarter. The PDNA rates for credit cards increased 20 basis points to 3.36 percent from the previous quarter. The multifamily PDNA rate increased 8 basis points from the prior quarter, the CRE PDNA rate increased 7 basis points, and the auto loan rate increased 5 basis points. These portfolios’ PDNA rates were above their pre-pandemic averages by 66 to 95 basis points.”
With inflation still adversely impacting American households, default probabilities will continue to rise and threaten banks’ credit portfolios. Moreover, if Trump goes ahead with his deportation and tariff threats, inflation will rise even more than the already high level. Adam Posen, President of Peterson Institute for International Economics, and his team do a great job of explaining how dangerous Trump’s economic plans are for Americans. Inflation could climb more than 4 percentage points higher by 2026. This level of inflation would make push millions of Americans to default on their mortgages and other credit products such as auto loans and credit cards. While allowances for credit losses have been reasonably high, they declined in the last quarter. If inflation stays where it is or worse yet, rises, credit losses need to go up, not down.
I am also concerned about the direction of liquid assets. Again, while levels in 2024 were reasonably stable. FDIC data shows that liquid assets as a percentage of all assets declined in the 3rd quarter of 2024. Deregulatory and inflationary pressures mean that banks should increase their high-quality liquid assets to be able to withstand any unexpected credit or stock market turmoil.
I urge legislators and regulators not to bow down to the pressure from bank lobbyists even more. Remember that their interests are profits; yours should be the safety and sanity of Americans who will be badly hurt if any bank implodes due to excessive risk taking, which is what always happens with deregulation. I have seen this movie before in my three decades in this business; it always ends the same way. Badly.
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