The past several years have been relatively placid for the banking industry. After the wholesale failure of the system during the financial crisis, banks gradually recovered their footing. Aided by essentially free money from the Federal Reserve, bailouts, and widespread federal and central bank guarantees, banks once again became rock-solid American institutions. As the expansion rolled on, companies and individuals did a much better job keeping up with their financial obligations. The result: record profits for banks and an extremely low rate of bank failure.
In 2016, banks covered by the Federal Deposit Insurance Corporation showed huge profits and only a few banks failed last year. What’s more, the banks that failed were truly marginal, counting just 18 branches
But something worrisome is happening in 2017. So far this year, seven banks have already failed. More important, the banks that are failing are significantly larger. Guaranty Bank of Milwaukee bit the dust. A few months before, it was First NBC Bank of New Orleans Financial failure begets financial failure. For the first time in nearly a decade, this is what it has started to happen in US.
The U.S. economy is, by most accounts, rolling along. The current expansion is now in its 95th month. The economy has added payroll jobs for a record 79 months, and the unemployment rate is at 4.4 percent.
When expansions get longer, a few things happen. Banks, consumers, and companies all get more confident about their ability to handle debt, which leads to more credit being extended. At the same time, lenders seeking growth start to become more aggressive about putting money in the hands of people. Once all the people who can easily afford to purchase cars have taken car loans or mortgages, banks seek out more marginal borrowers in order to keep boosting their profits. And once credit gets distributed a little too widely, borrowers begin to default—even if nothing else changes in the economy or the climate for credit.
But something is changing. For the first time in a decade, the Federal Reserve is raising interest rates—thus increasing the cost of borrowing and servicing debt. Before December 2015, when the Fed boosted the federal funds rate from zero to 0.25 percent, it had been 9.5 years since the Fed last raised the interest rates it controls. The Federal Reserve has since raised rates in 0.25 percent increments twice. Yes, interest rates are still remarkably low, and the moves have been small. But it’s the direction that matters. For a decade, people in the economy had been conditioned to think that interest rates don’t really go up—and they borrowed and planned accordingly.
When interest rates were low and generally declining, people could refinance their way out of trouble. But when interest rates go up, it becomes harder to avoid trouble. And so as rates rise this deep in an economic cycle, it’s not surprising that the rate of financial failures is increasing. After hitting the lowest level since 2006 in the third quarter of 2016, mortgage delinquency rates rose in the fourth quarter to 4.8 percent. The delinquency rate on credit card loans, while still at a very low level, rose for three straight quarters in 2016. The volume of auto loans that are delinquent is rising rapidly. All these metrics will likely continue to rise.
In addition, it’s worth recalling that this recovery has been remarkably uneven. Amid the long expansions, there are always pockets of distress. So if you’ve extended credit aggressively in an area that is struggling to begin with, and interest rates start to rise, you’re likely to run into trouble quickly. Guaranty Bank, which failed in early May, lends primarily to lower- and middle-income people in urban areas, a demographic slice that hasn’t fully participated in the expansion. New Orleans’ First NBC Bank, the biggest failure so far this year, is a relatively new bank (founded 2006) that lent heavily to the oil and gas industry, which has been traumatized by persistently low prices.
None of this is to say we’re going to have a repeat of the financial crisis or there is any danger of a recession but the spate of failures should set off alarms. The forces that have helped turn the direction of delinquency rates around are still very much there. The business cycle continues to age, What’s more, a sudden increase in financial failures tends to push banks and other lenders to pull back credit and tighten lending terms—which means it will be harder for people to refinance their way out of trouble or ask for leniency.
The two biggest democracies have different perceptions and strengths to tackle the problem of growing NPA and sick financial institutions but we have seldom heard of failure of Banks in India that credits the US with more transparency and freedom for the institutions to decide future of their own. Yes the Indian system remains protective under the bigg Government umbrella