Fed: ‘Great Deal of Uncertainty’ Around Credit Quality Due to COVID-19

Banks “remained well capitalized throughout” the COVID-19 pandemic, even as they absorbed large losses, according to the Federal Reserve’s latest financial stability report released today. The Fed noted that capital ratios have “generally recovered to pre-pandemic levels” since the last report was issued in May 2020, but that the pandemic “highlighted how vulnerabilities related to leverage and funding risk at nonbank financial institutions could amplify shocks in the financial system in times of stress.”

Corporate debt—which was already high at the start of the pandemic—has continued to rise and credit quality for small businesses “has worsened notably” since the COVID-19 outbreak began, the Fed said. Additionally, a weakening in household finances could pose “a significant medium-run vulnerability for the financial system,” according to the report. However, it noted that a deterioration in household credit quality has been mitigated by government support programs, including expanded unemployment and economic impact payments.

“Because of the implementation of loss-mitigation programs, government stimulus payments and PPP loans, the true status of credit quality is not reflected in loan delinquencies,” the Fed cautioned. “As these programs expire, some of these accounts in loss mitigation could roll into and be reflected in higher bank delinquency rates later this year and early next year, followed by higher charge-off rates and losses. All told, a great deal of uncertainty about the future path of these losses remains.”

The Fed also flagged several near-term risks to the financial system, including a prolonged economic slowdown, disruptions in global dollar funding markets and stresses emanating from Europe—including those related to COVID-19 and a potential no-deal Brexit—as well as emerging market economies. It also addressed the implications of climate change for financial stability.