America’s 6 biggest banks are expected to set aside $4.5 billion in Q3 to cover future loan losses — why that’s a clear bad sign for the global economy

America's 6 largest banks are expected to set aside $4.5 billion to cover future loan losses in the third quarter - why that's a clear bad sign for the global economy

America’s 6 largest banks are expected to set aside $4.5 billion to cover future loan losses in the third quarter – why that’s a clear bad sign for the global economy

Fears of a looming recession and a strengthening economy are urging the country’s big banks to prepare for the worst.

According to a report by Bloomberg, six of the largest banks in the US — JPMorgan Chase, Bank of America, Citigroup, Goldman Sachs, Wells Fargo and Morgan Stanley — are planning to set aside around $4.5 billion for loan loss protection in their third quarter lay. quarterly profit.

Banks typically provide for loan losses when there are concerns that borrowers will not be able to make their payments.

It’s not hard to understand why they make the effort to prepare. Relentless increases in the Federal Funds Rate set by the Federal Reserve — now at 3% to 3.25% — have already caused borrowers to default on loans, credit card payments and other adjustable-rate debt.

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And by setting aside these massive reserves, banks are signaling that they can expect further losses in the future as consumers continue to feel the pressure of rising interest rates and searing inflation.

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What these banks are reacting to

Lenders are already beginning to feel the effects of the Fed’s inflationary war. Four of the country’s largest banks are expected to report losses in their quarterly earnings reports this week, including JPMorgan Chase, Wells Fargo, Citigroup and Morgan Stanley.

Normally, a higher interest rate would be a good thing for banks – their earnings tend to rise with interest rates. But banks are seeing a pullback amid shaky markets – fewer deals are being done and investors are holding back as warning signs of a recession linger.

And that has prompted many banks to build up their loss reserves.

The amount banks add to their loan loss provisions is then deducted from their earnings. Conversely, when a bank releases these reserves, that money is added to its earnings.

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Banks and lenders adjust their cash reserves to match the potential losses on their outstanding loans — putting money aside for problem loans that are late or not paid at all. If a loan is not repaid, a bank draws on the loss reserves to cover it.

Generally, when banks release their loan loss provisions, it means the economy is healthy and borrowers will have no trouble making payments. If they build them up, it’s a sign that they expect borrowers will have trouble making payments.

Many lenders were forced to replenish tens of billions of dollars in reserves during the March 2020 crash when the pandemic hit — but released them the following year as the economy recovered. And now they need to reverse course – for good reason.

Concerns started in the last quarter

In the second quarter of this year, JPMorgan reported significant losses and built up $428 million in reserves for bad loans. The sentiment behind it doesn’t seem to have changed for the bank.

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Earlier this week, JPMorgan CEO Jamie Dimon warned that “some kind of recession” was coming in six to nine months, according to CNBC.

WellsFargo also suffered large losses in the second quarter. The bank reported that its profits were halved as it pushed funds into its reserves to cover potential losses.

These losses are already eating away at the banks’ profits. According to the Federal Deposit Insurance Corporation, a federal banking regulator, prepayments—loans that are 30 to 89 days past due—increased by $11.4 billion (25%) in the second quarter of 2022 compared to the same period in 2021.

As the Federal Reserve continues its aggressive fight against inflation, banks appear to be expecting defaults to continue as consumers and business customers find it harder to make payments in a strained economy.

This article is informational only and should not be construed as advice. It is provided without any guarantee.

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