Banking industry faces ‘significant downside risks’: FDIC chair

FDIC Chair Martin Gruenberg said Thursday that the US banking industry “continues to face significant downside risks” from inflation and high interest rates, which could cause profitability and credit quality to weaken.

The top regulator issued his warning as the FDIC released a comprehensive look at how thousands of institutions fared during the second quarter, one of the most tumultuous periods for banking since the 2008 financial crisis.

The quarter included the seizure of San Francisco lender First Republic, which was the second-largest bank failure in US history, and wild fluctuations in the stocks of other regional banks. Two other mid-sized lenders, Silicon Valley Bank and Signature Bank, went down during the first quarter.

Read more: What the latest Fed rate hike plan means for bank accounts, CDs, loans, and credit cards

What the report showed is that deposits declined for the fifth quarter in a row, largely due to the exit of uninsured account holders.

The decline of $98.6 billion, or 0.5%, “moderated substantially” from the $472 billion outflow during the first quarter, but it continued to place pressure on banks to raise their funding costs to keep account holders who are searching for higher yields. That, in turn, ate into a key measure of profitability.

Federal Deposit Insurance Corporation Chair Martin Gruenberg. (Manuel Balce Ceneta/AP Photo)

Those pressures, Gruenberg said in a separate release, pose “significant challenges” to the industry, along with concerns about a weakening market for commercial real estate. Banks are major lenders to commercial property owners across the US.

All of these developments “will continue to be matters of supervisory attention by the FDIC,” he added.

The ‘problem’ list

There were signs in the FDIC’s report, which includes statistics gathered from more than 4,600 institutions, that the worst of the industry’s chaos had eased.

The regulator, for example, did not add any more US banks to its “problem” list, which numbers 43. Assets held by institutions on that list decreased by $10 billion to $43 billion.

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Banks on the FDIC’s problem list typically have multiple weaknesses identified by regulators in confidential supervisory ratings. They can be seized and shut down unless the issues are resolved quickly.

That list swelled into the hundreds during the industry’s last big crisis which began in 2008.

There were some other signs of increased resiliency. Overall profits would have been roughly flat from the prior quarter if not for the effects of the three failed banks on the institutions that acquired their assets. And from the year-ago period, overall profits were up 9.9%.

But the concern within the industry is the direction of a more specific measure of bank profitability known as the net interest margin, which measures the difference between what lenders make from loans and pay for their deposits.

That margin declined by 7 basis points from the previous quarter to 3.28%. Loan yields increased 40 basis points during the quarter to 5.32% but deposit costs rose 43 basis points to 2.05%.

There is the chance that measure could keep tightening as banks fight outside sources, especially money market funds, for the loyalty of their depositors.

Read more: The best high-yield money market accounts for September 2023

In fact, money market fund assets reached a new all-time high last week as interest rates above 5% continue to attract investors at a time when the Federal Reserve appears determined to keep rates elevated for some time.

“The second quarter’s deposit story appears to have been more about pricing pressures from depositors, seeking higher yields, often at non-bank financial institutions, particularly money market mutual funds,” Gruenberg said.

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