As shown in Exhibit 1, The Clearing House Bank Conditions Index (TCHBCI) was at 80 in the fourth quarter of 2016 and was little changed relative to the third quarter. The Clearing House introduced TCHBCI at the end of 2016 in order to provide a quantitative assessment of the resilience of the U.S. banking sector using a wide range of common indicators of bank condition and expects to update the index at a quarterly frequency. The index synthesizes data on 23 banking indicators, grouped into six categories: capital, liquidity, risk-taking, asset quality, interconnectedness and profitability. Our website contains all series that comprise the index and a description of the methodology.
The aggregate index assesses the resilience of the banking sector from the first quarter of 1996 to the present (last quarter of 2016) on a scale of 0 to 100. A value of 100 indicates that the banking sector is at its most resilient since the first quarter of 1996; conversely, a value of 0 implies that the U.S. banking sector is at its most vulnerable. Although a value of 100 is associated with a maximally resilient banking system, it is probably not the level most conducive of robust economic growth. On the one hand, having extremely safe banks is desirable from a financial stability perspective as vulnerabilities in the banking system amplify and propagate adverse economic and financial shocks, resulting in severe and persistent economic downturns. On the other hand, a banking system that is excessively risk-averse will also have an adverse impact on economic growth over the medium and longer term by restraining credit to borrowers that are bank-dependent (e.g., small businesses) and via higher lending rates on loans to all types of borrowers. We find that GDP growth is maximized when the TCHBCI is about 60. Currently the TCHBCI is above that level, suggesting that bank caution or banking regulations could be holding-up economic growth somewhat.
Exhibit 2 depicts the heat map of TCHBCI and for each of the six categories that comprise the aggregate index. Even though the aggregate index was about unchanged in the fourth quarter of 2016, the capital category increased and the interconnectedness category declined (increasing resilience of the banking sector) while the risk-taking category increased and profitability declined (increasing vulnerability). The increase in the level of resiliency from capital is driven by the rise in the market leverage ratio under stress, shown in the left panel of Exhibit 3. Following the presidential election, the equity valuation of banks rose markedly on the expectation of tax reform, infrastructure spending and the easing of regulatory burden for banks. The degree of resiliency of the interconnectedness category also improved due to a continuation in the decline of measures of interconnectedness among banks (not shown).
In contrast, the risk-taking category registered a slight decrease in resiliency as a result of an easing in lending standards on commercial and industrial loans, but it remained suppressed in part by a very low level of the ratio of loans to deposits and the still ongoing recovery in loan growth. Although the increase in risk-taking reduces the degree of resiliency of the index, reduces reduction in the level of risk-aversion of banks toward historically normal levels could be more supportive of economic growth by expanding credit to bank-dependent borrowers. Meanwhile, bank profitability worsened further reflecting a continuation of the decline in fee income at banks and still subdued net interest margins. Lastly, the liquidity and asset quality categories of the index were little changed in the fourth quarter of 2016. On the liquidity side, while the gap between the maturity of assets and liabilities continued to rise, banks’ holdings of high-quality liquid assets also increased (right-panel of Exhibit 3) and the dependence on short-term wholesale funding remains at very low levels (not shown). Similarly, on the asset quality side the changes in the individual components were mixed. Although net charge offs edged up, all other asset quality measured improved slightly over the quarter.
Finally, Exhibit 4 provides the readings on each of the six categories that comprise TCHBCI at two different points in time: (i) the end of 2008, the nadir of the past crisis and (ii) the most recent quarter. Points plotted near the center of the chart indicate a high degree of vulnerability in that category while points plotted near the rim indicate high resiliency. As shown by the red line, in the fourth quarter of 2008, the quarter immediately after the failure of Lehman Brothers, almost all categories of the aggregate index were at very low levels indicating the presence of acute vulnerabilities. Over the years since the crisis, almost all categories of the index have improved considerably, as shown by the blue line, especially the capital and liquidity positions of U.S. banks. These improvements largely reflect the efforts of banks to increase their capital and liquidity following the financial crisis, the more stringent capital and liquidity requirements that are part of Basel III, and the U.S. stress tests.
Disclaimer: The views expressed in this post are those of the author(s) and do not necessarily reflect the position of The Clearing House or its membership.