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Profits and balance sheet developments at U.S. commercial banks in 1992.

U.S. commercial banks in 1992 continued their recovery from the difficulties of recent years. Bank profits were $31 1/2 billion, an increase of $14 billion over 1991, and a record 0.92 percent of average assets. Return on equity also increased sharply, although it remained in the range of historical experience. Banks retained a sizable proportion of earnings, which, along with a substantial issuance of new debt and equity, significantly bolstered their capital. The restructuring of bank balance sheets, which began in 1990 continued last year, with loan portfolios contracting and securities holdings expanding.(1)

Commercial banks in 1992 benefited from the improving U.S. economy. Real gross domestic product rose 3 percent, extending the expansion that began in the spring of 1991, and inflation remained low. Policy easings by the Federal Reserve pushed short-term rates down about 1 percentage point in 1992, but yields on thirty-year Treasury bonds fell only about 1/4 percentage point. Apparently, stubborn expectations of inflation, election uncertainties, and deficit fears limited the decline in longer rates, tiltinhg upward an already steep yield curve.

The brightened macroeconomic picture and lower market interest rates clearly contributed to the improved performance of U.S. commercial banks. Profits (chart 1) were buoyed by a decline in loan loss provisions to their lowest level since 1988 (table 1). The drop in provisioning was matched by a similar decline in charge-offs, and delinquency rates improved moderately. In addition, the effect of the reduction in market interest rates was smaller for returns on bank assets than for rates paid on bank liabilities. This difference is consistent with the longer average maturity of bank assets relative to bank liabilities. As a consequence, the spread between interest income and interest expense (the net interest margin) widened last year.

Financial markets responded favorably to developments in the banking industry as well as to the improved economic outlook. Bank stock prices out-performed the broader market in 1992, and spread between bank debt and Treasury securities narrowed. The robustness of the financial markets encouraged banks to issue record amounts of new capital last year. These new issues, coupled with high levels of retained profits, boosted bank capital about $32 billion in 1992. This increase raised the industry's capital-asset ratio 1/2 percentage point, to more than 7 percent. In addition, banks supplemented their total capital positions by issuing $8-3/4 billion of subordinated debt.

Bank balance sheets expanded slowly in 1992. Assets increased just 2 1/4 percent; and, as in 1991, total loans declined, while holdings of U.S. Treasury and federal agency securities increased substantially. Weak loan demand appeared to be the principal cause of the decline in lending, although continued tightness in standards and terms on new loans probably also played a role. Along with the lackluster rate of asset growth and the substantial issuance of bank capital, the growth of deposits was weak in 1992--a weakness echoed in sluggish growth of the broader monetary aggregates.

The improvements in industry health in 1992 are clearly reflected in measures of bank distress. The number of banks classified by the Federal Deposit Insurance Corporation (FDIC) as "problem banks" fell almost one-fourth, to 787, and their assets declined by about the same proportion over the year. One hundred federally insured commercial banks failed last year, compares with 108 failures in 1991 and more than 200 in each year from 1987 through 1989.

The consolidation of the banking industry continued in 1992. The FDIC reported 428 unassisted mergers in 1991, down from 459 the previous year. Two of these mergers, however--Bank of America with Security Pacific, and Chemical Bank with Manufacturer's Hanover Trust--involved four of the ten largest banks in the country. The number of commercial banks declined somewhat more rapidly in 1992 than in 1991, falling more than 3 3/4 percent. The more rapid decline resulted from a drop in the number of new banks: Only fifty-one charters for new banks were issued in 1992, the lowest number since the early 1950s. (In addition, twenty-one new charters were issued for bridge banks.) As a result of industry consolidation, employment in the banking sector declined 1/2 percent in 1992, about one-third of the drop reported in 1991. As in 1991, the total number of commercial bank branches increased about 1/2 percent. In part, the recent increases in branches are likely the result of banks' acquisition of thrifts.


Many of the trends seen in 1992 have lasted into 1993. Continued improvements in asset quality and high net interest margins have contributed to robust first-quarter bank profits. Loan growth has remained weak, as the composition of banks' assets continued to shift away from loans and toward securities. In contrast, bank stock prices declined in the spring, apparently as a result of investors' anticipation that higher interest rates might reduce bank profits.


Bank balance sheets grew little overall in 1992 (table 2). Bank lending continued to decline as business and households sought to reduce debt burdens, as large business shifted toward longterm funding, and as banks' terms and standards on loans remained relatively firm. The weakness in lending was mirrored in a rapid accumulation of U.S. Treasury and agency securities. On the liability side, the low volume of lending depressed bank demand for deposit funds. Moreover, banks substituted capital for deposits. (See appendix tables A.1 and A.2 for detailed information on income, expenses, and the composition of bank assets and liabilities for 1985-92.)


Total bank assets grew 2 1/4 percent--a small pickup over the 1 1/4 percent rise in 1991. The volume of bank loans fell 1 percent, a smaller decline than in 1991. As in 1991, bank holdings of securities climbed sharply, rising 11 1/2 percent.


The behavior of both commercial and industrial and consumer loans was similar to that of total loans; both fell, but less than in 1991. In contrast, real estate loans grew about 2 percent, somewhat less than in 1991. Total loan growth improved in most regions.

Commercial and industrial loans. Commercial and industrial loans fell 4 percent, the third straight year of decline. These loans ran off at banks of all sizes, although they declined least at smaller banks. On the supply side, banks apparently did not significantly ease their standards and terms on commercial industrial loans. On the demand side, firms borrowed less, both because of the relatively slow pace of the expansion and because of the success of large firms in substituting longer-term financing for bank borrowing.

Response to the Federal Reserve's periodic Senior Loan Officer Opinion Survey on Bank Lending Practices (LPS) showed that banks substantially tightened their terms and standards on commercial and industrial loans during 1990 and early 1991 (chart 2). The respondents attributed this tightening primarily to the work economy and to industry-specific problems, although some of them indicated that capital adequacy or regulatory pressure was a concern. In any case, some tightening was to be expected, given the substantial losses that banks faced as a result of the economic down-turn of 1990-91, the collapse in the commercial real estate market, and the relaxed underwriting standards in the late 1980s. Terms and standards do not appear to have eased until early 1993, however, despite substantial improvements in the performance of the U.S. economy and significantly higher levels of bank capital in 1992.

Similarly, data on loan spreads from the Federal Reserve's Survey of Terms of Bank Lending to Business show that rates on floating-rate prime-based loans rose sharply relative to the federal funds rate in late 1990 and have remained elevated (chart 3). The behavior of these spreads since 1990 reflects primarily the spread of the prime rate over the federal fund rate, although spreads over the prime rate have declined for loans under large commitments. Similarly, spreads over the cost of funds for fixed-rate loans--which are primarily to larger customers--have narrowed somewhat over the past twpo years. These declined may reflect the reduced riskiness of such loans resulting from tighter lending standards.

The demand for bank credit in 1992 was sapped by the efforts of firms to lock in long-term financing at nominal interest rates not seen since the early 1970s. Similar shifts to long-term finance followed the reductions in long-term interest rates in the mid-1970s and the early 1980s (chart 4). In addition, the robust stock market encouraged many firms to issue equity and to use the proceeds to pay down bank debt. The volume of bond and equity issuance with the primary purpose of retiring bank debt was by, one estimate, considerably more than the decline in business lending by banks last year.

Real estate loans. The pace of expansion in real estate loans at commercial banks was 2 percent in 1992, down about 3/4 percentage point from the pace in 1991. As in 1991, most of the increases in real estate lending was concentrated in the residential sector, with bank loans for one- to four-family mortages growing 7 1/2 percent last year. Within that sector, lending under home equity lines of credit increased 4 1/4 percent in 1992, less than one-third the 14-1/2 percent increases in 1991. Both the firmness in residential mortgages and the weakening in borrowing under home equity lines probably stem, in part, from the use of the proceeds of mortgage refinancings to pay down other, higher-cost debts, including heme equity lines. Responses to the LPS indicate that demand for residential mortgages increased strongly in 1992, while demand for home equity lines of credit increased more modestloy. In addition, a few banks reported easing their terms on residential mortgages, and many respndents cited an increased willingness to make general-purposee loans to consumers, including home equity loans.

In recent years, an increasing proportion of bank financing of residential mortgages has taken the form of mortgage-backed securities, as banks have substituted these securities for the direct holding of residential mortgages. The mortgage-backed securities provide banks with greater liquidity, lower capital charges, increased diversification, and--in the case of Government National Mortgage Association (GNMA) securities--government backing. Mortgage-backed securities now constitute more than one-third of total (direct plus securitized) commercial bank financing of residential mortgages.

Commercial real estate markets in 1992 continued to suffer from the effects of excess supply created in the 1980s. Vacancy rates for industrial space remained very high after peaking in early 1992. Vacancy rates for commercial office space remained high in the first half of 1992 but improved in the second half (chart 5). Commercial real estate prices were reported to be still falling at the end of 1992, although perhaps more slowly than in 1991. A January 1993 FDIC survey found that the number of examiners and liquidators who thought that the real estate market was improving was about double the number who thought it was deteriorating. Nonetheless, almost one-third of those suveyed thought that commercial real estate prices were declining, and few reported that prices were rising.

The substantial problems facing the commercial real estate market in recent years explain, in part, the tightening of standards on such loans reported in the LPS (chart 2). In addition, the tighter standards likely reflect the realization that standards in the 1980s were insufficiently rigorous. In contrast to the standards on commercial and industrial loans, banks responding to the LPS reported a further small net tightening of standards on commercial real estate loans in 1992.

Consumer loans. Consumer loans held by banks fell 1-1/2 percent in 1992 after dropping 2-1/2 percent in 1991. The slower rate of decline in 1992 was attributable to a smaller reduction in the holdings of consumer loans by large banks, in part the result of decreased securitization. Taking account of consumer lending by banks increased about 1/2 percent in 1992, a slightly larger increase than that in 1991. In contrast to the pattern in recent years, both credit card debt and installment and other consumer debt declined in 1992. The weakness in consumer lending in part appears to have resulted from households' use of low-interest bank deposits to pay down relatively high-cost consumer loans--contributing thereby to the weakness in bank deposits, especially small time deposits, and in the broader monetary aggregates. As noted above, consumers may also have used the proceeds of mortgage refinancing to pay down some of their consumer debts.

The regional pattern of loab growth. The growth in banking lending varied substantially across Federal Reserve Districts. All Districts other than San Francisco showed improvement over 1991, with several showing a return to positive growth (table 3). In the Northeast, lending continued to decline in the New York and Boston Districts, while banks in the Philadelphia District posted a small increase. Loans declined more slowly in the Boston District than in the nation as a whole last year, a substantial improvement in the relative performance of the District over 1990 and 1991. In the Southeast, lending continued to decline in the Richmond District but recovered in the Atlanta District. In the Midwest (the Cleveland, Chicago, and St. Louis Districts), loan growth picked up moderately. Loan growth in the central part of the country (the Mineapolis, Kansas City, and Dallas Districts) picked up strongly in 1992, showing the biggest improvement of any region. In the West (the San Francisco District), lending declined more sharply than in 1991, as defense cutbacks and continued problems with commercial real estate contributed to the weakness in the regional economy.



Bank holdings of securities increased 11 1/2 percent, only 3 percentages points below the 1991 pace. After three years of rapid growth, securities now account for more than 20 percent of bank assets. Although this share is quite high by recent standards, it is similar to that reached in 1975 and smaller than the shares reported before the mid-1960s. Much of the recent growth was concentrated in mortgage-backed securities issued or guaranteed by federal agencies. Such securities accounted for more than 60 percent of the increase in securities holdings between March 1990 and December 1992.

Holdings of both U.S. Treasury securities and federal agency securities grew rapidly in 1992. Treasury securities led the way with growth of 24 percent, while holdings of federal agency securities--primarily mortgage-backed securities issued by the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation or guaranteed by GNMA--grew 12-3/4 percent.

Some commentators have suggested that banks have increased their holdings of U.S. Treasury and agency securities as a result of the imposition of risk-based capital standards. Because these standards assign low or zero risk weights to these securities, poorly capitalized banks can raise their risk-weighted capital ratios by substituting U.S. Treasury and agency securities for loans in their portfolios. Although such as shift has occurred, well-capitalized banks have increased their holdings of such securities considerably more than poorly capitalized banks, suggesting that the primary impetus to the growth in bank securities investments arises elsewhere.

In contrast to their holdings of Treasury and agency securities, bank holdings of municipal securities continued to run off, although at a slower pace than that in 1991. The Tax Reform Act of 1986 removed the tax advantages to banks of new purchases of these bonds but provided that municipal securities held by banks at the time of the change would be treated under the old rules. As a result, bank holdings of municipal securities have been declining as those accumulated before the tax change mature or are called.

Despite the incentives offered by the steep yield curve, banks do not appear to have increased the maturity of their securities holdings. In fact, available data suggest that the average maturity of bankheld securities may have shortened slightly in 1992 (table 4). The reported maturities of mortgage-backed securities likely overstate their actual expected maturity. Banks are instructed to report the maturity of these securities based on the stated maturity of the underlying mortgages, but they generally hold the shorter-maturity tranches of these securities. Responses to questions on a recent LPS indicate that a majority of bank-held mortgage-backed securities have expected maturities of less than five years. More than 60 percent of the respondents reported that the average expected maturity of their securities had declined during 1992. Similarly, a recent survey by the American Bankers Association indicated that the weighted average maturity of all bank-held securities declined more than six months in 1992, to 3-1/2 years. The decline in maturity was largest for small banks, although small banks continue to have somewhat longer average maturities than medium-sized and large banks have. About one-fourth of the LPS respondents indicated that a further shortening of maturities was desirable. Most of them attributed the change in desired maturity to existing or anticipated rules regarding the reporting of security values on financial statements.


Even if the difference between reported maturity and expected maturity is taken into account, bank holdings of securities have maturities that are longer than those of bank loans. Thus, the maturity of bank assets has increased slightly in recent years as a result of the growing share of assets invested in securities. The maturities of bank time deposits have increase since 1990, perhaps, as a result of bank efforts to match the maturities of bank assets and liabilities. The large decline in the share of time deposits in bank liabilities, however, has more than offset the effect of the lengthening of time deposit maturities, leading to a fall in the average maturity of bank liabilities.

Off-Balance-Sheet Items

In contrast to the decline in bank loans, unused loan commitments increased to 36 1/2 percent of assets, from 34 3/4 percent, during 1992--another indication that the weakness in bank lending reflects weak demand. The credit-equivalent value of all interest rate contracts at banks (including the value of interest rate swaps, futures contracts, forward contracts, and option contracts) increased to 1.8 percent of bank assets at the end of 1992--up from 1.7 percent at the end of 1991 and 1.0 percent at the end of 1990. The credit-equivalent value of all foreign exchange contracts (including the value of exchange rate swaps, commitments to buy foreign exchange, and option contracts) edged down slightly, from 4.2 percent of commercial bank assets at the end of 1991 to 4.0 percent at the end of 1992, but remains well above the year-end 1990 level of 3.6 percent. As they were in past years, most of these instruments are held by the ten largest banks.(2)

In contrast, the volume of bank letters of credit outstanding declined for the second consecutive year in 1992. The total amount of letters of credit (the sum of financial standby, performance standby, and commercial letters of credit) fell from 6-1/3 percent of bank assets at the end of 1990 to 5-1/2 percent at the end of 1992. The decline was at least partly the result of two factors. First, the difficulties faced by the banking system in recent years have likely reduced the number of U.S. commercial banks with the high ratings needed to provide financial standby letters of credit for commercial paper issuers. Indeed, financial standby letters of credit have declined more rapidly than letters of credit of the other types since 1990. Second, the new risk-based capital standards require capital backing for letters of credit with maturities of more than one year and thus increase their cost.


Against a backdrop of weak loan growth, banks did not aggressively seek deposits in 1992. With assest growth restrained and capital issuance running at a record pacew, bank liabilities grew just 1-1/2 percent. Within total liabilities, the composition of deposits shifted toward savings and transaction deposits and sharply away from time deposits.

Nontransaction Deposits

Rates on certificates of deposit fell substantially in 1991 and 1992, primarily because of the decline in market interest rates. As is usual when market rates fall rapidly (chart 6, top panel), rates on savings deposits declined more slowly than rates on time deposits (chart 6, bottom panel). With a narrowing deposits (chart 6, bottom panel). With a narrowing spread between rates on time deposits and those on savings deposits, small time deposits fell 12 1/2 percent while saving deposits (including money market deposit accounts) increased 13 percent. Low interest rates on bank deposits also encouraged outflow to stock and bond mutual funds (chart 7). Net monthly flows into long-term bond funds averaged $9-1/2 billion, while flows into equity funds aaveraged $7-1/4 billion.

In addition, banks continued to allow their large time deposits, which are relatively costly, to run off. Such deposits fell 26 percent in 1992 and almost 20 percent in 1991.

Transaction Deposits

The drop in interest rates also contributed to the rapid growth in transaction deposits in 1992. Lower rates on other assets reduced the opportunity cost of holding funds in low-yielding transaction accounts, increasing their attractiveness. In addition, lower mortgage interests rates led to a surge in mortgage refinancings. The increase in refinancings, in turn, temporarily increased the level of transaction deposits because mortgage servicers hold prepayments of mortgages securitized by GNMA of FNMA in transaction accounts for up to ix weeks. Over the course of the year, domestic demand deposits rose 12-1/2 percent and other checkable deposits 18-1/2 percent.


Profitability in the commercial banking industry rose sharply last year, with the return on assets jumping from 0.53 to 0.92 percent and the return on equity moving up to 13 percent (chart 1). All major components of bank profitability improved (table 5). More than half of the increase in neh income was attributable to wide net interest margins. These higher margins resulted in part from the uneven decline in market interest rates during 1991 and 1992, which trimmed the return on relatively longer-maturity bank assets by less than the rates paid on shorter-maturity bank liabilities. Interest margins also benefited from wider spreads relative to market rates as a result of high lending rates and unaggressive deposit pricing. In addition, the return on assets improved because of lower provisions for future loan losses, as charge-offsXand delinquency rates edged down and as the total dollar volume of bank loans declined. The ddop in interest rates helped banks realize higher capital gains on sales of securities, although the share of bank profits derived from securities gains declined in 1992. Net noninterest margins were up only slightly, as increases in fee income were largely offset by higher noninterest expenses, which were likely associated with industry consolidation an, increases in off-balance-sheet activity.
5. Selected income and expense items, by size of bank,
 Year and Net Net Net
 size of bank income interest noninterest Loss
 margin margin provisions
All banks......... .92 3.90 -1.92 .77
 Small........... 1.08 4.34 -2.51 .39
 Medium.......... .91 4.22 -2.21 .77
 Large, excluding
 ten largest 1.01 3.85 -1.75 .81
 Ten largest..... .65 3.18 -1.24 1.09
All banks......... .53 3.61 -1.93 1.02
 Small........... .80 4.09 -2.50 .51
 Medium.......... .61 3.99 -2.13 1.04
 Large, excluding
 ten largest .50 3.46 -1.73 1.21
 Ten largest..... .21 2.92 -1.42 1.20
All banks......... .49 3.46 -1.82 .96
 Small........... .79 4.08 -2.46 .50
 Medium.......... .55 3.85 -2.02 1.09
 Large, excluding
 ten largest .24 3.27 1.61 1.30
 Ten largest..... .47 2.68 -1.25 .76
(1). As a percentage of average net consolidated assets.

All size categories of banks showed improvements in earnings in 1992, with the large and ten largest banks showing the greatest gains. At large banks excluding the ten largest, net interest margins widened 10 basis points more than the industry average, and loss provisions fell 15 basis points more. The ten largest banks, like other banks, enjoyed wider interest margins and a drop in loss provisioning last year.(3). Unlike other banks, however, they significantly improved their net noninterest margins by an average of 18 basis points, in part because of substantial gains from foreign exchange transactions. Nonetheless, relatively low net interest margins and high rates of provisioning kept net income at the ten largest banks well below the industry average. Although small banks posted the smallest gains in net income compared with that in 1991 (their rate of provisioning edged down only 12 basis points), they remained the most profitable group in 1992.

Bank income varied widely by Federal Reserve District (table 3). The largest improvements in earnings were among Districts that had returns on assets near or below the industry average in 1991. Banks in these Districts, which typically have higher concentrations of commercial real estate loans, benefited from reductions in loss provisions and increases in net interest margins. The largest gain in 1992 was recorded by banks in the Boston District, which reversed their year-earlier losses, posting an average increase in return on assets of 88 basis points.

Despite higher earnings in 1992, dividend payouts as a percentage of average assets were roughly the same as in recent years. As a result, banks retained a substantial portion of their earnings, contributing, along with hefty issuance of equity and subordinated debt, to a significant improvement in their capital positions.

The strong 1992 results for banks showed through to the results for bank holding companies, whose return on assets averaged 0.82 percent, more than double the return in 1991 and the highest rate since 1988. The return on equity for holding companies was 12 percent, also the highest since 1988. Assets of holding companies grew 2-1/2 percent; the pace of that growth and its composition was similar to that at banks--securities at holding companies rose 14-3/4 percent, and loans and leases declined 1-3/4 percent.

Asset Quality and Loss Provisions

For the industry as a whole, asset quality improved in 1992 (table 6). Net charge-offs were 1-1/4 percent of outstanding loans, compared with 1-1/2 percent in 1991. Similarly, the average delinquency rate improved, dropping to 5-1/4 percent from 6 percent. In light of this progress, banks reduced their rate of loss provisioning to 1-1/4 percent of loans, down from more than 1-1/2 percent in 1991. On balance, provisions for the year slightly exceeded net charge-offs, and loss reserves as a percentage of loans continued to edge up (chart 8). Loan quality improved for most size categories of banks, but the ten largest continued to have relatively high charge-off and delinquency rates, especially on commercial real estate loans. 6. Measures of loan quality, by size of bank, 1990-92(1) Percent
Year and size of bank Net Delinquency Loss
 charge-offs rate provisions

All banks........... 1.29 5.24 1.31
 Small............. .58 3.82 .72
 Medium............ 1.20 4.55 1.28

 Large, excluding
 ten largest.. 1.43 5.10 1.34
 Ten largest....... 1.77 7.53 1.79

All banks........... 1.58 5.90 1.65
 Small............. .77 4.32 .92
 Medium............ 1.36 5.21 1.65
 Large, excluding
 ten largest.. 1.69 6.13 1.92
 Ten largest....... 2.37 7.69 1.87

All banks........... 1.42 5.23 1.64
 Small............. .70 4.20 089
 Medium............ 1.16 4.38 1.69
 Large, excluding
 ten largest.. 1.72 5.42 2.03
 Ten largest....... 1.92 6.85 1.18

(1). As a percentage of average outstanding loans. Delinquent loans are nonaccrual loans and those that are accruing interest but are more than thirty days past due.

Detailed data on net charge-offs and delinquencies by type of loan are available for medium-sized and large banks and for all banks with foreign offices (chart 9). Seasonally adjusted charge-off and delinquency rates for most major types of loans moved below their 1991 highs. For commercial and industrial loans, they dropped to the lower end of the ranges seen during the last ten years. Although delinquencies on real estate loans moved down, charge-offs remained particularly high, in large part because of lingering problems with commercial real estate.

Banks' experiences with commercial real estate loans have varied markedly (table 7).(4) The proportion of loan portfolios devoted to commercial real estate loans has tended to be lower at larger banks than at smaller ones, but the delinquency rates at larger banks have been much higher. Although most large banks have made some progress in cleaning up their holdings of commercial real estate loans, delinquency rates remain stubbornly high for the ten largest banks and banks in the Boston, New York, and San Francisco Federal Reserve Districts.

Interest Income and Expense

Although interest income as a percentage of average assets was 112 basis points lower in 1992 than in 1991, interest expense fell more, 141 basis points; hence, net interest margins at banks widened 29 basis points. Several factors contributed to higher net interest margins in 1992, but the bulk of the increase was attributable to changing interest rate relationships, which include the results of a steeper yield curve, relatively high lending rates, and unaggressive deposit pricing. As a consequence, although the gross rate of return on assets fell 125 basis points, rates paid on deposits fell more, 180 basis points.

To a lesser extent, net interest margins were bolstered by changes in the composition of bank assets and liabilities. On the asset side, banks shifted about 2-1/4 percent of their asset portfolios from loans to securities, which tend to have somewhat longer maturities than bank loans do. Still, about 35-1/2 percent of bank loans and leases at the end of 1992 had maturities greater than one year, a proportion virtually unchanged from the end of 1991 (table 4). By contrast, on the liability side, banks decreased the average maturity of their deposits by substituting away from time deposits toward liquid deposits and other funding sources, such as subordinated debt and equity.

Interest income and expense for the various bank size categories differed markedly. These differences can be traced to variations in the quality and the relative maturities of the groups' assets and liabilities. Interest margins for small and medium-sized firms were the highest of the four groups in 1992 (chart 10). Compared with larger-sized banks, banks in these two groups tend to have more assets that are better quality and have longer maturities. In addition, these banks are likely to tie their business loans more to the prime rate than to market rates. The widening of the spread of the prime rate over market rates (chart 3) has helped these banks to maintain higher rates of return on their loan portfolios. On the liability side, medium-sized banks were also able to obtain larger reductions in interest expenses by sharply reducing their reliance on time deposits to fund asset growth.

Noninterest Income and Expense

For the banking industry as a whole, noninterest expenses edged up 13 basis points relative to average assets while noninterest income increased by 14 basis points. Thus, the negative spread between noninterest income and expenses narrowed slightly in 1992 after widening 11 basis points in 1991. An important part of the turnaround in noninterest margins was the increase in fee income other than service charges on deposits. This pickup in revenues was about offset, however, by higher noninterest expenses that probably arose from industry consolidation and increases in off-balance-sheet activity.


Noninterest margins for the ten largest banks increased 18 basis points, well above the industry average (chart 11). Noninterest income at these banks was boosted in part by larger earnings on foreign exchange transactions. This group of banks was also able to hold down noninterest expenses in 1992, primarily by cutting occupancy costs. In contrast, while noninterest income increased at medium-sized and large banks other than the ten largest, expenses increased by more, and noninterest margins at those banks fell slightly.

Noninterest margins at small banks were unchanged in 1992. Fee income for these banks is more closely tied to service charges on deposits, which were also unchanged in 1992. These banks were also able to keep noninterest expenses in check. Small banks have had weaker growth in off-balance-sheet activity and, most likely, in associated expenses. In addition, smaller-sized institutions had higher quality assets than banks in other size categories in 1992 and may have had lower expenses for collection and legal services related to poor asset performance.

Changes in Capital

Despite the surge in net income in 1992, banks trimmed slightly their dividend payout rates, from 0.43 percent of average assets in 1991 to 0.42 percent last year. Consequently, retained income increased five-fold. to $17-1/4 billion (table 8). Banks further augmented their capital positions with substantial issues of new equity and subordinated debt. On an annual average basis, total equity capital rose 1/2 percent point, to more than 7 percent of average assets. The increase in capital was particularly impressive for the ten largest banks because of the relatively sharp improvement in their profits, a cut in dividend payments of one-third, and a significant issuance of new capital.


Banks' issuance of capital was aided by the strong performance of bank securities in 1992 (chart 12). Stock prices of regional and money center banks continued the rapid growth that characterized 1991, rising about four times faster than the S&P 500 stock index in 1992. Interest-rate spreads on bank holding company subordinated debt over Treasury securities, which peaked at more than 450 basis points in 1990, continued to decline, dropping below 100 basis points late in the year.

The recent increases in the capitalization of U.S. banks have been driven in part by three regulatory changes. First, under the Basle Accord, U.S. bank regulators imposed minimum capital adequacy guidelines in 1990 that became fully phased in on December 31, 1992. Under these guidelines, banks are expected to hold tier 1 capital--mainly common equity and perpetual preferred stock--of at least 4 percent of risk-weighted assets. They must also hold total capital--tier 1 plus tier 2--of at least 8 percent of risk-weighted assets. Tier 2 capital consists primarily of subordinated debt, nontier-1 preferred stock, and the allowance for loan losses. U.S. regulators have independently imposed limits on leverage based on banks' supervisory ratings. For the best-rated banks, tier 1 capital must be at least 3 percent of unweighted assets. In practice, however, most banks are required to hold tier 1 capital of at least 4 percent of unweighted assets.

The second regulatory change was the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), enacted on December 19, 1991. Among other things, the legislation set more stringent limits on bank capital, requiring U.S. regulators to establish five capital zones: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. To be well capitalized, for example, a commercial bank must have total capital of at least 10 percent of risk-weighted assets, tier 1 capital of at least 6 percent of risk-weighted assets, and tier 1 capital of at least 5 percent of total assets. Banks with sufficient capital but weak supervisory ratings may, however, be assigned to a lower capital zone.

With these limits, which became effective one year after the enactment of FDICIA, the law imposed restrictions on the activities of banks that are not well capitalized. For example, banks that are only adequately capitalized must obtain a waiver from the FDIC in order to accept brokered deposits, and they must apply to the FDIC for pass-through deposit insurance for pension plan deposits. Constraints on undercapitalized institutions are more stringent.

Finally, banks' demand for capital in 1992 was boosted by the introduction of risk-based deposit insurance premiums on January 1, 1993. Under the new FDIC rules, a bank's premium is determined by a two-step evaluation of the risk the bank poses to the Bank Insurance Fund. First, banks are divided into well-capitalized, adequately capitalized, and undercapitalized groups. Then each group is further divided into three subgroups based on regulators' evaluations of the institutions. Well-capitalized banks with strong evaluations will pay a premium of 23 basis points, the smallest premium currently allowed under FDICIA and the same that all banks paid in 1992. At the other extreme, the premiums for undercapitalized banks with poor evaluations will be 31 basis points.

With tHe large increases in capital achieved in 1992, most banks appeared to have satisfactory capital levels by year-end: The average bank had tier 1 capital equal to nearly 10 percent of risk-weighted assets and total capital of more than 12 percent of risk-weighted assets (chart 13). Capital ratios were highest for small banks; and, on average, even the largest banks had tier 1 capital of 6-1/2 percent of risk-weighted assets and total capital of 11 percent of risk-weighted assets. At year-end, about 94 percent of all U.S. banks, accounting for 89 percent of bank assets, were either well capitalized or adequately capitalized. A large majority of banks had substantial cushions of capital, with almost 80 percent of banks in the well-capitalized category. Well-capitalized banks accounted for nearly two-thirds of bank assets.

Even though most banks were well capitalized at the start of 1992, capital grew strongly during the year. Apparently, banks wanted to hold considerably more capital than required by statutes. Study of the behavior of individual banks suggests that many have set internal capital targets that are higher than the regulatory minimums. Banks have found that increased capital, besides inviting less regulatory scrutiny, lowers the rates they pay on uninsured liabilities.


Many of the trends seen in 1992 carried through into the first quarter of 1993. Bank profits were strong in the first quarter because of high net interest margins and low charge-offs. Balance sheet adjustments continued, with bank loans declining further in the first quarter and securities holdings rising rapidly. Banks continued to augment their capital through both high retained earnings and new capital issues. Bank stock prices declined in the spring, however, apparently because investors anticipated that higher interest rates might lower bank profits.

In March the federal banking agencies announced their intention to change regulatory requirements that may have restricted the supply of business credit without being essential to sound banking. Two of the changes were particularly noteworthy: First, the regulatory agencies agreed to allow strong and well-managed banks to establish a limited portfolio of "character" loans--loans to creditworthy small and medium-sized businesses that will not be subject to examiner criticism based on documentation. Second, the agencies proposed raising the minimum size of real estate loans requiring formal appraisals, from $100,000 to $250,000. The appraisal requirement had been singled out by LPS respondents as a substantial contraint on lending to small businesses.


(1.) Except where otherwise indicated, data in this article are from the quarterly Report of Condition and Income (Call Report) for insured domestic commerical banks and nondeposit trust companies. The data, which cover all such institutions that field at least one Call Report, consolidate information from foreign and domestic offices and have been adjusted to take account of mergers. Size categories of such institutions (hereafere called banks), which refer to assets at the start of each year, are as follows: small banks, less than $300 million; medium-sized banks, $300 million to $5 billion; large banks, $5 billion or more. The ten largest banks were selected as of December 1991, and this category includes the same banks for all years; mergers in 1992 reduced to eight the number of institutions in the category. Data for the 1985-91 period have been revised to reflect uniform definitions across time and to incorporate updated Call Report information. Data for years preceding 1985 are not strictly comparable to the 1985--92 data. In the tables, components may not sum to totals because of rounding.

(2.) See note 1 regarding the ten largest banks.

(3.) See note 1 regarding the ten largest banks.
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Author:English, William B.
Publication:Federal Reserve Bulletin
Date:Jul 1, 1993
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