Profits and balance sheet developments at U.S. commercial banks in 1996 - includes related articles on consolidation of commercial banks, credit card banks

Federal Reserve Bulletin, June, 1997 by William R. Nelson, Ann L. Owen

Over the past ten years, noninterest expense has been held in check in part by a decline in employment and occupancy costs as a percentage of revenue (chart 13). Employment levels in the industry fell during the late 1980s and early 1990s and have since remained about unchanged. Occupancy costs have likely benefited from the slow growth of the number of bank offices, which rose only 17 percent between 1986 and 1996, one-third the increase in revenue, adjusted for inflation, over that period. Furthermore, over the ten years, the inflation-adjusted cost per office fell more than 10 percent. These costs may have been contained in part by the growing popularity of low-cost supermarket branches. By contrast, other noninterest expense, a broad category that accounts for nearly half of noninterest expense and includes deposit insurance premiums, losses on the sale of various assets, amortization of intangible assets, expenditures for information processing services provided by others, and merger restructuring charges, has risen a bit relative to revenue. Nevertheless, the ratio of total noninterest expense to revenue has fallen over the past ten years; thus, at least by this common measure of efficiency, banks appear to have significantly streamlined their operations.

[Chart 13 ILLUSTRATION OMITTED]

Loss Provisioning and Loan Quality

Since 1992, the banking industry has been setting aside as a provision against losses on loans and leases amounts very close to their net charge-offs (chart 14). In keeping with this pattern, provisioning rose slightly last year, matching a small increase in net charge-offs. Although loan-loss provisioning relative to assets edged higher over the past two years, it was quite a bit lower at the end of 1996 than earlier in the 1990s and about the same as at the beginning of the 1980s. Banks were able to reduce provisioning in 1992 because improvements in loan quality and a contraction in loans sharply reduced their need for loan-loss reserves. In recent years, continued improvements in measured loan quality have allowed banks to equalize provisioning and net charge-offs, leaving the level of reserves unchanged. Although the ratio of reserves to loans fell in each of the past four years, the ratio of reserves to delinquent loans increased until 1995, fell only slightly last year, and was more than 80 percent at year-end (chart 15). However, net charge-offs grew faster than delinquencies, and the ratio of reserves to charge-offs fell fairly sharply in the past two years. Still, in 1996, loan-loss reserves were 3 1/2 times as large as net charge-offs in that year, a bit above average.

[Charts 14 & 15 ILLUSTRATION OMITTED]

Although the decline in provisioning relative to the levels in the troubled late 1980s and early 1990s has helped boost measures of bank profitability, banks would still be solidly profitable even if provisioning were much higher. For example, if provisioning had been double its actual level last year, the ratio of provisioning to assets would have been about 50 percent higher than its average level since 1970. Nevertheless, net interest income less provisioning would have equaled 3 percent of assets, slightly above the average level for this ratio since 1970. The return on assets would drop to a bit under 1 percent, but it would still be a bit above its average over the period, and the return on equity would fall to 11 1/2 percent, about equal to its average over the period.