With the release of its Q2 earnings, Bank of America announced that its provision for credit losses and charge-offs grew to $1.5 billion, an increase from the previous quarter’s total of $1.3 billion.
According to the company, net charge-offs—money the bank writes off and doesn’t expect to be paid back—nearly doubled to $1.5 billion from $869 million in the previous year. JP Morgan Chase made a similar disclosure last week during its Q2 results. Its credit loss provisions rose to $3.05 billion for the quarter, up from $1.88 billion in Q1.
Why, in a relatively strong economy, are banks seeing such a rise in their credit losses? Part of it is due to long-term trends. Banks have been normalizing their charge-offs and loss provisions since the pandemic. When it ended, there was a build-up of deposits on hand, quickly followed by an influx of cash into the system in the form of stimulus. Those effects are now wearing off.
In addition, the Federal Reserve’s stress tests, conducted last month, found that losses from Commercial and Industrial (C&I) loans are projected to rise as well. The Fed found that C&I loss rates are projected to rise to 8.1% from the 6.7% level seen in last year’s tests.
Fallout from Dodd-Frank
These are not the only reasons for the increase in loan loss provisions, according to Brian Riley, Co-Head of Payments at Javelin Strategy & Research. Due to Dodd-Frank, banks now have to be more proactive in preparing for potential losses.
“Since Dodd-Frank brought us Current Expected Credit Loss loan reserving, card issuers must prepare for their losses in advance,” Riley said. “The increase in loan loss reserves from Chase and Bank of America is indicative of an expected increase in losses. Funding loan losses in advance of the occurrence is the best practice for card issuers because it prepares their balance sheet for upcoming losses.
“It certainly is not shocking to see the reserves increase, and you can expect other issuers to do the same,” he said. “The most important takeaway here is that top issuers are expecting higher losses. The Fed’s recent stress tests indicate that issuer will get through the deterioration, but it is clear that they are beginning to circle the wagons as a defensive play.”