As shown in Exhibit 1, The Clearing House Bank Conditions Index (TCHBCI) decreased slightly in the second quarter of 2017 after displaying its highest level of resiliency in the first quarter of this year. Overall, the changes in each of the six subcomponents of the index – capital, liquidity, risk aversion, asset quality, interconnectedness, and profitability – were mixed. The liquidity category experienced a decline this quarter but remained close to its highest level of resiliency, and the index also showed a modest increase in risk-taking by banks. In contrast, the capital, asset quality, and profitability categories continued to show improvements in the degree of resiliency. However, as pointed out in a recent TCH blog post, the level of profitability of the banking sector remains well below the average level of profitability observed in the decade prior to the start of the financial crisis.
Exhibit 2 plots a heat map of TCHBCI and the six categories that make up the aggregate index. Values near 100 (higher resiliency) are shown in blue, while values near 0 (higher vulnerability) are shown in red. The minor decrease in the degree of resiliency of the overall index in the second quarter is in most part driven by the decline observed in the liquidity category, although U.S. banks continued to have highly liquid balance sheets and sizable liquidity buffers. All subcomponents of the liquidity category experienced slight declines. For instance, the share of assets financed with short-term wholesale liabilities has risen over the past few quarters but remains close to its historical low level. The increase in wholesale funding over the past few quarters has been driven by brokered deposits and other borrowed money with maturities of less than one year. Other measures of liquidity also decreased slightly; the gap between the maturity of assets and liabilities continued to rise, and banks’ share of high-quality liquid assets ticked down.
In addition, the index also registered a modest decrease in the level of risk-aversion by banks this quarter, albeit at a very subdued level. The rise in risk-taking was mainly driven by an easing of lending standards and a small increase in the ratio of loans to nominal GDP. That said, headwinds arising from tighter banking regulations have likely continued to put downward pressure on loan growth, particularly on loans to borrowers with less-than-perfect or insufficient credit histories. Meanwhile, bank interconnectedness edged down this quarter.
The remaining three categories in Exhibit 2 (profitability, capital, and asset quality) show greater resilience in the banking sector. Banks recover from adverse shocks primarily by rebuilding capital through retained earnings, so a more profitable banking system is more resilient. Although bank profitability is still subdued relative to historical standards, it rose in the second quarter of 2017, driven by improvements in net interest margins and increases in non-interest income. In addition, regulatory capital increased further this quarter and reached its highest level since the start of the index. Finally, most subcomponents of the asset quality index improved over the second quarter.
Exhibit 3 provides the readings on each of the six categories that make up TCHBCI at two points in time: (i) the end of 2008, the nadir of the past crisis, and (ii) the most recent quarter. Points plotted near the center of the chart indicate a high degree of vulnerability in that category, while points plotted near the rim indicate high resiliency. As shown by the red line, in the fourth quarter of 2008, the quarter immediately after the failure of Lehman Brothers, almost all categories of the aggregate index were at very low levels, indicating the presence of acute vulnerabilities. As shown by the blue line, almost all categories of the index have improved considerably over the years since the crisis, especially the capital and liquidity positions of U.S. banks. These improvements largely reflect the efforts of commercial banks to increase their capital and liquidity following the financial crisis, the more stringent capital and liquidity requirements that are part of Basel III, and the U.S. stress tests.