Banks need to bounce back so that small businesses to thrive. But is the banking sector really on the road to recovery? Are U.S. Banks Getting Healthier?
The fate of virtually every small business in the United States is tied to the health of the banking sector. Banks are the institutions that circulate and multiply money throughout our economy. Think of them as financial funnels; when the funnels are in working order, money from depositors enters the narrow stem, multiplies and exits the wide mouth, reaching companies and consumers who put the money to productive use. This multiplier effect is a key source of capital, and without it our economy would only be a fraction of its current size.
Since 2008, however, the banking funnel has been inverted. Money from the federal government—well over a trillion dollars—has entered the mouth of the banking funnel but only a fraction of that has exited and been injected back into the economy; most of that money has stayed on the balance sheets of the banks and other financial institutions. From the perspective the banks, this is a prudent decision on their part. They want to have as large a financial cushion as possible against future defaults from failed loans and investments. But the results are clear: Having an inverted funnel has made it difficult for businesses to grow.
Making the financial funnel work for us
So how do we fix the funnel so that it works as it’s intended to? An important first step is for banks to improve their financial health. If bank executives are more confident about their ability to recoup their investments and improve performance, they will be more inclined to lend money and play an active role in stimulating our economy back to growth. A recent report by the Federal Deposit Insurance Corporation (“FDIC”) indicates that we may very well be experiencing the first signs of this return to health.
According to the FDIC’s most recent Quarterly Banking Profile, the financial condition of banking institutions that are FDIC members have improved significantly. During the second quarter of 2011:
- FDIC institutions earned $28 billion in net income, an increase of 38 percent over the same period last year and is the eighth consecutive quarter of net income growth.
- Nearly 60 percent of banks reported increased profits. More important, less than 16 percent of institutions reported a loss—the lowest percentage since the start of the banking crisis in 2008.
- FDIC institutions reported a more than 20 percent increase in their return on assets ratio, a very important measure of bank heath. Banking institutions with less than $1 billion in assets, like community banks, saw their return on assets more than double.
Loan loss reserves provide an important clue
The best indicator that financial institutions may begin increasing their lending activity is found in the loan loss reserves statistics. Loan loss reserves represent money that banks must set aside to cover expected losses from nonperforming loans. If banks increase loan loss reserves, it means they expect times to get worse and they will be far more cautious in lending. During the second quarter, loan loss reserves at FDIC institutions declined 53 percent compared to the previous quarter with two-thirds of institutions reducing their provisions or keeping them at the same level. This marks the seventh consecutive quarter that provisions were lowered.
These positive results provide a firm foundation to justify increased lending activity among banking institutions. Like any business, banks need to make money and they don’t do that by keeping capital on their books; they need to lend. I believe we will see modest increases in lending over the next several quarters.
