The Clearing House Bank Conditions Index (TCHBCI) shows the first quarter of 2017 had the highest level of resiliency since the start of the index in the first quarter of 1996 (see Exhibit 1). The aggregate index goes from 0 to 100 with 100 being the most resilient, and since it is at its sample peak, it is at 100.
The increase relative to the fourth quarter of last year was widespread across all categories of the index. Specifically, the categories that experienced the most notable increases were risk-aversion, profitability, interconnectedness and asset quality. The increase in TCHBCI over the past year generally reflects continued increases across all categories of the index. The findings are similar to those reported in the FDIC’s “Insured Institutions Performance” report last week.
The increase in the level of banks’ risk-aversion is in most part driven by the decline in the ratio of loans-to-GDP, shown in the left panel of Exhibit 2. In particular, the pace of growth in loans and leases slowed markedly from 2.7 percent in the fourth quarter of last year to -0.3 percent in the first quarter of 2017. The decline in loans and leases on banks’ books in the first quarter is likely attributable to the recent increase in both short-term and long-term interest rates. On the business side, in response to the rise of short-term rates and the expectation that the Federal Reserve will increase short-term interest rates further this year, corporations turned to the bond market to secure funding at what are still relatively low interest rates, and have used some of those proceeds to pay down some of their outstanding C&I loans. On the residential real estate side, higher longer-term interest rates also caused a noticeable decline in mortgage refinancing applications. That said, regulatory headwinds arising from tighter banking regulations have likely continued to put downward pressure on loan growth.
The other categories of the index also shifted toward levels consistent with greater bank resilience. Banks recover from adverse shocks primarily by rebuilding capital through retained earnings, so a more profitable banking system is more resilient. Although bank profitability is still low by historical standards, it rose in first quarter of 2017, mainly because of a rise of noninterest income as net interest margins were about unchanged. Moreover, bank interconnectedness continued to decline (consistent with an increase in resilience) due importantly to a reduction in the “conditional value of value at risk” or CoVaR, a market-based measure of systemic risk that we added to the index this quarter (as well as historically) as an additional measure of interconnectedness. The CoVaR, which is shown in the right panel of Exhibit 2, estimates the losses the financial system would incur if one of the U.S. globally systemically important banks were to be in distress. On the asset quality side, all the subcomponents improved over the quarter with the exception of net charge offs which were about unchanged. Among the remaining categories of the index, capital and liquidity rose further driven by increases in risk-based regulatory capital ratios and holdings of high-quality liquid assets, respectively. On the liquidity side although the gap between the maturity of assets and liabilities continued to rise, banks’ dependence on short-term wholesale funding remains at very low levels (not shown). Exhibit 3 depicts the heat map of TCHBCI and for each of the six categories that comprise the aggregate index.
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 will update the index at a quarterly frequency. The index synthesizes data on 24 banking indicators, grouped into six categories: capital, liquidity, risk-aversion, asset quality, interconnectedness and profitability. As noted above, this quarter we added CoVaR to the interconnectedness category. The measure was added to the interconnectedness category over the entire sample. All the series that comprise the index and a description of the methodology can be found here.
The aggregate index assesses the resilience of the banking sector from the first quarter of 1996 to the present (first quarter of 2017) on a scale of 0 to 100. As noted above, 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 at its highest when the TCHBCI is about 60 (see the dashed line in Exhibit 1). Currently the TCHBCI is at 100, strongly suggesting that bank caution or banking regulations could be holding-up economic growth.
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.