While traditional sources of U.S. bank revenue have struggled during the COVID-19 pandemic, overall bank profitability soared to all-time highs in 2021. Senior Economist Rajdeep Sengupta and Research Associate Adam Byrdak explored the reasons and the outlook. Their findings were published in a November 2021 Economic Bulletin.
Which factors have driven the surge?
Return on assets (ROA), the most common indicator of overall bank profitability, reached a record high in the first quarter of 2021. However, net interest margins
(NIMs) reached their lowest level in recent years by June 2021. NIMs capture the difference between the interest banks receive on loans, securities and other assets and the interest they pay on interest-bearing non-deposit and deposit liabilities. Accordingly, NIMs are widely accepted as an indicator of profitability from banks’ core activities. The fact that banks continued to see such high ROA while margins from their core business activities faltered is remarkable.
Even more remarkable is that the growth in bank ROA came during a period of high asset growth. Bank balance sheets expanded dramatically in the early days of the pandemic, attributed largely to increases in credit line withdrawals and deposit inflows. That said, the divergence reflected in the ROA surge amid the decline in NIMs is largely explained by a substantial reduction in banks’ loan loss provisions. Loan loss provision is an income expense used by banks to prepare for expected defaults.
How has policy played a role?
Extraordinary policy measures undertaken by the Federal Reserve and the U.S. Treasury after
the COVID-19 pandemic began—including loan forbearance under the Coronavirus Aid, Relief, and Economic Security (CARES) Act—aided a rapid rebound in financial market conditions. As conditions improved, the high rates of default that banks projected at the start of the pandemic became increasingly unlikely to materialize. The reduction in projected loan losses helped overall bank profitability increase without impacting NIMs.
Will profitability continue rising?
Such positive contributions to banks’ overall profitability as those seen in 2021 are likely to be transitory, and the future of bank profitability in a low-rate environment is much less certain.
Moreover, recent lack of loan growth, low yields on earning assets, and the pressure to increase income from fee-based sources could create incentives for more risk-taking.
Read Economic Review articles and other research from the Kansas City Fed.