Saturday, December 19, 2009

How Healthy are US Banks?

December has seen a spate of good news about US banks. Many banks report a return to profitability, with record earnings in some cases. The largest banks have repaid, or are in the process of repaying, the money that they borrowed from the government's Troubled Asset Relief Program (TARP). The Treasury even claims to have earned a profit on TARP funds repaid so far. Does all this mean that the banking system has returned to health?

Not so fast. There is some bad news, too. On balance, it appears that the US banking system has a long way to go to be fully healthy. Here are some of the negatives:
  • Bank lending activity has not increased since the inception of TARP in October, 2008. In fact, by some measures lending has declined.
  • Bank profits are coming from trading activities, not from lending. This limits the positive spillover from Wall Street to Main Street.
  • Banks point out that one reason they are not lending more is that lending remains risky in a weak economy. This argument seems justified at least in part. For example, the percentage of nonperforming loans continues to rise, especially at the largest banks.
  • The Federal Deposit Insurance Corporation (FDIC) reports that the number and size of problem banks continues to increase. "Problem banks" are those that have received low marks on regulatory reviews, even though they remain solvent for the time being.
Even the Treasury's claim to have profited from TARP repayments is subject to question. As part of a deal on terms of repayment, some banks have received lenient rulings on carry-forward of past losses. These rulings will cost the Treasury billions of dollars in future tax revenues, offsetting any TARP profits from interest payments and sale of warrants. Furthermore, although the largest banks have repaid their TARP funds, many smaller banks have not, and some may never succeed in doing so.

Some critics believe that banks should not have been allowed to repay TARP funds so soon. They say that the primary motive for early repayments is the desire to escape government limits on bonuses for top executives and traders. Early repayment may come at the expense of shareholder value, and failure to rebuild capital could lead to the need for more bailouts in the future.

To download a free set of PowerPoint slides summarizing these points, click on this link. If you find the slides useful for your course, please post a comment!

No comments:

Post a Comment