The banking sector’s economic resilience was a source of stability in 2020, though monitoring key risks remains necessary, according to the FDIC’s 2021 coverage of credit and market risk. The review additionally monitored consumer debt, small business lending, and focused specifically on the banking industry’s performance during the Covid-19 pandemic.
Banks face particular challenges of a low-interest rate environment, though their liquidity positions remain strong. As both deposits and market uncertainty grew quickly in 2020, however, community banks were able to allocate a higher share of their assets to readily available liquidity sources, ultimately decreasing their dependence on wholesale funding.
Low interest rates continue to pressure banks’ bottom lines, as the net interest margin reached a record low. Community banks face interest rate risk challenges in low interest rate and tepid loan environments. The ratio of loans to total assets also declined for community banks in 2020, as deposits exceeded loan demands. FDIC Insured institutions reported a 36.5 percent decline in income in 2020, as deposits increased by 22.6 percent.
Bank exposure to non-bank financial lending institutions increased significantly in 2020, particularly in mortgage lending. This growth increased the banking industry’s vulnerability to risks from third party lending activities, the report said.
As consumers saved and deposits surged, community banks’ reliance on wholesale funding declined. However, banks should be wary of potential changes in depositor behavior as pandemic conditions quickly evolve. Strong capital buffers and federal support programs muted some of the effects of the pandemic on the banking industry, though banks continue to navigate risks across many sectors.
Conditions deteriorated for consumers and businesses as governments enacted shutdowns and unemployment rose to the double digits. Though government programs supported balance sheets and consumer loan performances, consumer loan volumes fell in 2020 as households pulled back on spending and instead used the aid to reduce outstanding loan balances. Conditions are improving in the wake of government assistance, though the outlook for consumer asset quality remains uncertain. As the economy improves, however, there could be more opportunities for consumer lending, as well as stronger loan performance.
Small business conditions weakened significantly in 2020, but small business lending increased, primarily due to banks’ participation in the SBA’s Paycheck Protection Program. Additionally, small business closures and bankruptcies didn’t yield deteriorated credit. However, while asset quality remains manageable, the long-term effect of the pandemic on small business asset quality is uncertain, posing credit risks for banks.
CRE also took a hit from the pandemic, as lodging and retail sectors weakened immediately at its onset. The rise in remote work, along with shifts in behaviors and preferences, could have long-term implications on CRE outlook. The volume of CRE loans reached a record high at the end of 2020, as some of the historically riskier categories of CRE loans grew slightly, though still 40 percent below the 2008 peak. CRE loan performance metrics remained manageable at FDIC-insured institutions.
With rebounding commodity prices and record levels of government support, the agriculture industry withstood the volatile market conditions of 2020. Asset quality and farmland equity was strong, enabling farmers to restructure loans to manage operating losses and replenish working capital. Farm income is expected to decline in 2021, though remain higher than historic levels.
Housing activity bounced back after starts and sales plunged at the beginning of the pandemic. There was a record increase in home prices in 2020 due to a combination of low interest rates, increased demand to accommodate remote work, and a limited supply of homes. With slightly higher lending volumes and strong refinancing activity, banks benefited from the increase.
The energy market experienced sharp declines in 2020, though banks exposed to energy lending remained resilient. Energy prices plunged as energy demand declined across the world due to the pandemic, though oil prices improved in the second half of the year. Oil and gas producers continue to experience challenges, and poor operational performance and escalating environmental, social and governmental risks contributed to capital scarcity for producers.
Corporate debt levels were already high before the pandemic, and accelerated as bond issuance surged in 2020. As corporate debt increased and GDP declined, the corporate debt-to-GDP ratio rose to an all-time high. Exposed to the risks through direct loans and lines of credit to corporations, holdings of collateralized loan obligations, and participation in the arranging of leveraged loans and corporate bonds, the banks with loans concentrated in hard-hit industries could face higher credit losses as those firms struggle to recover from the pandemic.