By Joseph Otting, 31st U.S. Comptroller of the Currency
Few would have predicted the strength of banks in the United States 11 years after Treasury Secretary Hank Paulson called together the chief executive officers of the nine largest to inject into them $125 billion in liquidity by purchasing preferred stock. From that meeting on October 13, 2008, US banks have returned from the brink to “take over the world”.[i] The strength of banks in the United States today reflects more than a decade of great work by banks’ boards and management as well as regulators and suggests a cultural shift toward comprehensive risk management.
How did that change occur? And what can global regulators and bankers learn from the return of US banks?
Responding to a crisis
Volumes have been written about the crisis, its contagion and the role of the Troubled Asset Relief Program (TARP) in recovery.[ii] Some forget that the United States House of Representatives voted against authorizing the TARP on September 29, 2008. The markets greeted that decision with the largest single-day point drop to date. Confidence was shaken. Congress responded by voting to authorize the TARP on October 3. Ten days later, the Treasury launched the Capital Purchase Program (CPP) and injected $125 billion into the nine largest domestic banks and allowed them to participate in the Federal Deposit Insurance Corporation’s (FDIC’s) debt and transaction account-guarantee program. Markets liked the news, jumping 11 percent the next day. Confidence was on the mend.
The Emergency Economic Stabilization Act of 2008 authorized $700 billion for the TARP, but that full amount was never spent. It was reduced to $475 billion by the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010. Of that $475 billion, the Department of the Treasury disbursed $442 billion—$245 billion to 707 banks of all sizes, $68 billion to bail out American International Group (AIG), $80 billion to the big three US automakers, $20 billion to credit markets and $30 billion to refinance and modify troubled home mortgages. Since that time, the Treasury has been reimbursed $443 billion, including $276 billion from banks, $73 billion from AIG, $71 billion from auto companies and $24 billion from credit markets (see figure 1).[iii] That is nearly a 13-percent return on the TARP funds invested in US banks. As of September 10, 2019, just $17 million of the original TARP investment remained in two small banks. [iv]
While it was one of many options, the TARP, and more specifically the CPP, helped restore confidence in US banks and pave the way for a large-scale economic recovery; but there is a more dynamic story of how the American banking system survived to rise to where it is today.
Central banks around the globe stepped in, dropping interest rates and buying bonds and debt in large measure that came to be known as quantitative easing (QE). In the United States, the Federal Reserve moved to QE more quickly than its European counterparts, beginning QE1 on November 25, 2008, with $800 billion in purchases of bank debt, U.S. Treasury notes and mortgage-backed securities. This helped provide additional liquidity and restore a floor to asset prices.
To address lingering doubts regarding the resiliency of the largest banks a year and a half after the CPP began, US bank regulators would make stress testing a household term by announcing the results of the Supervisory Capital Assessment Program (SCAP). Then Comptroller of the Currency John Dugan declared that the “results of the stress test demonstrate the strength of the banking system and its ability to withstand losses and sustain lending, even if economic conditions are more severe than currently anticipated”.[v] The SCAP brought transparency to the condition of the largest banks by naming names and showing in graphic details how each would perform under various scenarios. [vi] This transparency was an important contributor to rebuilding investor and consumer confidence, which was still on the mend.
Policies changed, too. Regulators put new standards for capital and liquidity in place.[vii] Prohibitions against the riskiest practices were established.[viii] Expectations for risk management and governance were raised.[ix] Requirements for stress testing were codified. Domestic and international policy responses to the crisis were swift and expansive. In fighting the flames amidst the crisis, each reaction was calibrated to address a particular risk. As early as 2011, there were calls to consider the combined effect of regulatory reactions to the crisis,[x] particularly on small community banks. While the response helped restore the financial system to orderly function, the many changes on small community banks resulted in increased regulatory burden, even though most community banks in the United States did not engage in the risky practices contributing to the scale of the crisis. It would be another seven years before Congress and policymakers rebalanced the regulatory framework through the bipartisan leadership of Senator Mike Crapo and the passing of Senate Bill 2155 (the Economic Growth, Regulatory Relief, and Consumer Protection Act).[xi]
Commercial banks in the United States also helped themselves and played a meaningful role in recovering from the Great Recession. During the crisis, large commercial banks were sources of strength for the banking system and the overall economy. They helped triage troubled assets and institutions by buying troubled banks, betting on the long-term return in open-bank solutions that minimized impact on taxpayers and reduced the need for additional government intervention. Banks and investors also bought the assets of the 414 US banks that failed from 2008 through the end of 2011.[xii] From these assets, some banks expanded and others built new, stronger, commercially viable institutions that could continue serving the credit needs of their community’s consumers and businesses. Despite the failures, insured deposits did not lose one penny. Investment banks such as Goldman Sachs and Morgan Stanley, which operated outside the commercial-banking system before the crisis, became commercial banks to access Federal Reserve services.
Banks in the United States also responded responsibly by largely reducing risky activity from their operations. US policies and practices require banks to aggressively work through troubled assets. As a result, American banks acted upon the requirements to deal with 90-day-past-due or impaired and troubled assets much more quickly than did banks in Europe and Asia, and that helped banks in the United States to rebound more quickly than their global rivals, putting US banks in a position of strength as recovery accelerated into growth and opportunity.
The diversity, scale and resiliency of its workforce and consumer base were other inherent advantages that contributed to a quicker recovery in the United States. Unemployment hit almost 10 percent in 2010 but was cut in half by 2015.[xiii] Unemployment at the end of 2018 was 3.9 percent. By comparison, unemployment in the eurozone was also roughly 10 percent in 2010 but swelled to more than 12 percent by 2013 and remains near 7.5 percent today—nearly double the US rate.[xiv] More people working means more consumer spending and greater ability to service personal debt. US household debt compared with gross domestic product (GDP) reached a high in excess of 90 percent of GDP during the Great Recession but has receded from that high, falling steadily to just more than 75 percent of GDP during the first quarter of 2019.[xv] In this case, the strength of the nation truly resided in its people.
Those quick actions to respond to weaknesses seen in 2008 and to shore up an economy and put people back to work gave banks in the United States a firm base from which to grow and claw back the advantage that European and Asian banks had gained in the 1990s. Three other forces helped ensure US banks remained an engine for economic opportunity and growth. Corporate-tax-rate reductions gave banks a boost in 2018. Key interest rates have risen from historic lows. And regulators and policymakers have worked to recalibrate the US regulatory framework to retain critical reforms imposed in response to the financial crisis and eliminate unnecessary regulatory burden.
How far from the brink have US banks come?
Today, banks in the United States are as healthy as they have been at any point in my 35-year career. The capital-to-total-assets ratio globally hovers around 10.3 percent, and in the United States, that ratio approaches almost 12 percent.[xvi] Return on equity (ROE) exceeded 12 percent at the end of the second quarter of 2019, the highest level since 2006.[xvii] Meanwhile return on equity of eurozone banks hovered around 6 percent at the end of the first quarter of 2019.[xviii]
Asset quality among US banks is also approaching pre-crisis levels, with the overall charge-off rate for all loans of commercial banks falling to .47 percent from 3.14 percent at the end of 2009.[xix]
From that base, banks in the United States have flexed their competitive muscle. According to The Wall Street Journal, banks in the country earned 62 percent of global investment fees in 2018, 70 percent of merger fees and 60 percent of stock commissions.[xx] The efficiency at US banks is greater than at their international counterparts, with US banks’ cost-to-income (CTI) ratio at about 58.6 in 2018, while the CTI for eurozone banks at the end of 2018 was 65.8 percent[xxi]—with German banks at 79.9, France at 68.1 and the United Kingdom at 64.7.[xxii]
That all means more money in the bank with profits of the banking sector in the United States increasing by 6.4 percent from a year ago to reach $123.3 billion through the second quarter of 2019.[xxiii]
While US banks have come a long way, a regulator’s primary role is to scan the horizon for storm clouds and identify risk where least expected.
At the Office of the Comptroller of the Currency, we have not forgotten the tremendous toll that the financial crisis took on consumers, investors and communities. Today, identifying, assessing and communicating risks to the federal banking system is a significant part of our job. Twice a year, we publish a Semiannual Risk Perspective that provides a systemic view of risks facing banks and helps set priorities for our bank examiners for the next six to twelve months. Our most recent publication highlighted four risks:[xxiv]
- Credit quality is strong when measured by traditional performance metrics, but successive years of growth, incremental easing in underwriting, risk layering and building credit concentrations have resulted in accumulated risk in loan portfolios.
- Operational risk is elevated as banks adapt to a changing and increasingly complex operating environment. Key drivers for operational risk include cybersecurity threats as well as innovation in financial products and services, and increasing use of third parties to support operations that are not effectively understood, implemented and controlled.
- Compliance risk related to the Bank Secrecy Act/Anti-Money Laundering (BSA/AML) is high as banks remain challenged to effectively manage money-laundering risks.
- Interest-rate risk and the related liquidity-risk implications pose potential challenges to earnings, given the uncertain rate environment, competitive pressures, changes in technology and untested depositor behavior.
To remain globally competitive and profitable and to continue serving as engines of growth and opportunity, banks—and regulators—must watch these risks closely.
Regulators, banks and policy leaders must understand the impact of the comprehensive steps taken in response to the last crisis to restore confidence, rebuild capital and provide liquidity. Acting quickly and decisively not only to stop the deterioration but also to work through troubled assets quickly helped put banks back on firm ground. By reestablishing a sound foundation, banks were then positioned to do what they do best—help create economic opportunity and return financial vibrancy to communities.
We know too well that banking and economies are cyclical and that the reasons differ for each recession, but we will be better armed to respond to the next crisis by remembering the lessons of the last.
[i] Liz Hoffman and Telis Demos. “How U.S. Banks Took Over the World.” The Wall Street Journal. September 4, 2019.
[ii] Andre Ross Sorkin. Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System—and Themselves. Viking. 2009. See also Henry M. Paulson, Jr. On the Brink: Inside the Race to Stop the Collapse of the Global Financial System. Business Plus. 2013. Ben S. Bernanke, Timothy F. Geithner, and Henry M. Paulson, Jr. Firefighting: The Financial Crisis and Its Lessons. Penguin Books. 2019.
[iii] See “Disposition of Tarp Funds To Date.” U.S. Department of the Treasury (https://www.treasury.gov/initiatives/financial-stability/reports/Pages/TARP-Tracker.aspx). Accessed September 12, 2019.
[iv] “Monthly Report to Congress August 2019.” U.S. Department of the Treasury (https://www.treasury.gov/initiatives/financial-stability/reports/Documents/2019.08%20August%20Monthly%20Report%20to%20Congress.pdf). September 10, 2019. Page 3. Banks remaining include OneUnited Bank and Harbor Bankshares Corporation.
[v] “Statement of Comptroller Dugan on the Results of the Supervisory Capital Assessment Program.” OCC News Release 2009-48 (https://www.occ.gov/news-issuances/news-releases/2009/nr-occ-2009-48.html). May 7, 2009.
[vi] “The Supervisory Capital Assessment Program: Overview of Results.” The Board of Governors of the Federal Reserve System (https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20090507a1.pdf). May 7, 2009.
[vii] “Regulatory Capital Rule.” OCC Bulletin 2013-23 (https://occ.gov/news-issuances/bulletins/2013/bulletin-2013-23.html). October 11, 2013. See also “Regulatory Capital – Enhanced Supplementary Leverage Ratio.” OCC Bulletin 2014-18 (https://occ.gov/news-issuances/bulletins/2014/bulletin-2014-18.html). May 1, 2014. See also “Liquidity Coverage Ratio Final Rule.” OCC Bulletin 2014-51 (https://occ.gov/news-issuances/bulletins/2014/bulletin-2014-51.html). October 17, 2014.
[viii] Final rules implementing the Volcker Rule (Section 619 of the Dodd-Frank Act) were first approved on December 10, 2013. Rule was subsequently revised by the Economic Growth Act of 2018 with final rules approved to modify the Volcker Rule in 2019. Comprehensive revision was made in August 2019.
[ix] “OCC Finalizes Its Heightened Standards for Large Financial Institutions.” OCC News Release (https://www.occ.gov/news-issuances/news-releases/2014/nr-occ-2014-117.html). September 2, 2014.
[x] “Remarks by John Walsh Acting Comptroller of the Currency Before the Centre for the Study of Financial Innovation.” OCC Speeches. (https://www.occ.gov/news-issuances/speeches/2011/pub-speech-2011-78.pdf). June 21, 2011.
[xi] “Remarks by President Trump at Signing of S. 2155, Economic Growth, Regulatory Relief, and Consumer Protection Act.” The White House (https://www.whitehouse.gov/briefings-statements/remarks-president-trump-signing-s-2155-economic-growth-regulatory-relief-consumer-protection-act/). May 24, 2018.
[xii] FDIC Data (https://www.fdic.gov/bank/historical/bank/2008/index.html).
[xiii] “Labor Force Statistics.” U.S. Bureau of Labor Statistics. (https://data.bls.gov/timeseries/LNU04000000?periods=Annual+Data&periods_option=specific_periods&years_option=all_years). Accessed September 12, 2019.
[xiv] “Euro Area Unemployment Rate.” Trading Economics (https://tradingeconomics.com/euro-area/unemployment-rate). Accessed September 12, 2019.
[xv] “Household Debt to GDP for United States.” FRED Economic Data. Federal Reserve Bank of St. Louis (https://fred.stlouisfed.org/series/HDTGPDUSQ163N). Accessed September 12, 2019.
[xvi] “Bank Capital to Asset Ratio.” The World Bank (https://data.worldbank.org/indicator/FB.BNK.CAPA.ZS?view=chart). Accessed September 12, 2019.
[xvii] “Return on Average Equity for all U.S. Banks.” FRED Economic Data. Federal Reserve Bank of St. Louis (https://fred.stlouisfed.org/series/USROE). Accessed September 12, 2019.
[xviii] “Supervisory banking statistics.” European Central Bank (https://www.bankingsupervision.europa.eu/banking/statistics/html/index.en.html). Accessed September 12, 2019.
[xix] “Charge-Off Rate on All Loans, All Commercial Banks.” FRED Economic Data. Federal Reserve Bank of St. Louis (https://fred.stlouisfed.org/series/CORALACBN). Accessed September 18, 2019.
[xx] Liz Hoffman and Telis Demos. “How U.S. Banks Took Over the World.” The Wall Street Journal. September 4, 2019.
[xxi] “Supervisory banking statistics.” European Central Bank (https://www.bankingsupervision.europa.eu/banking/statistics/html/index.en.html). Accessed September 12, 2019.
[xxii] Gabe Ledonne and Francis Garrido. “Bank Cost-To-Income Ratios Improve In Americas Amid Worldwide Split.” S&P Global (https://www.spglobal.com/marketintelligence/en/news-insights/research/cost-to-income-ratios-of-banks-worldwide-2019). August 26, 2019.
[xxiii] “U.S. banking sector reports $60.7 billion in profits for first quarter of 2019.” Reuters (https://www.reuters.com/article/us-usa-banks-results/u-s-banking-sector-reports-60-7-billion-in-profits-for-first-quarter-of-2019-idUSKCN1SZ1L4). May 29, 2019.
[xxiv] Semiannual Risk Perspective, OCC. Spring 2019 (https://www.occ.gov/publications-and-resources/publications/semiannual-risk-perspective/files/semiannual-risk-perspective-spring-2019.html).