Banks Are Hiding How Much Trouble They Are In

This week, the Financial Times reported that new reporting rules set to take effect in the autumn will allow banks to hide troubled loans and conceal signs of distress in their lending portfolios.

The new rules mean U.S. banks no longer have to disclose the total outstanding amount of loans whose terms were modified to keep borrowers from falling behind on repayments. Instead, banks need only report loans modified within the past 12 months. This shift may make it harder to track a key indicator of portfolio health, since a high share of troubled loans can be an early sign of financial stress. Under the previous standard, in place since the 1970s, a modified loan had to be flagged as such for the remainder of its life. The change is especially consequential for larger banks, which have been the primary users of these modifications.

The Financial Times quoted Rebel Cole, a former Federal Reserve Board staff economist who is now a finance professor at Florida Atlantic University, as saying, “It’s a terrible decision. It’s more opacity during a time when we already have too much opacity.”

If you follow our banking work, you know banks are seeing sharp increases in bad loans across several credit segments, including CRE, commercial and industrial lending, credit cards, student loans, and auto loans. Large banks also have significant exposure to shadow lenders, which remain a black box even to regulators. It is therefore unsurprising that they are lobbying to change reporting rules to conceal troubled loans.

The leading advocate for this reporting change was the Bank Policy Institute, a lobbying group we have pointed out previously for its efforts to push major changes in bank regulation. The Bank Policy Institute represents JPMorgan, Citigroup, and Goldman Sachs.

Last year, the Bank Policy Institute launched an unprecedented campaign against changes to capital requirements for the largest banks that were proposed by the Fed. The group reportedly hired one of the country’s top trial lawyers and planned to sue the Fed if it introduced those changes. Furthermore, Goldman Sachs recruited dozens of small-business owners from across the country and escorted them to meet senators in Washington, urging them to ask the Fed to reconsider the proposed capital requirements. The banking lobby even used billboards and a TV ad campaign, suggesting that every American had an opinion about Basel III when very few knew about the issue.

This campaign was apparently successful. The Fed announced that it had cut the proposed increase to capital requirements for the largest U.S. banks by more than half, ultimately raising requirements by 9%. As a reminder, the initial plan was a 19% increase, later reduced to 16%.

The Fed also introduced several changes that give investment banks latitude to engage in accounting maneuvers to lower their operational-risk requirements by reclassifying portions of trading losses as fee expenses. In addition, the Fed made changes to its annual stress test that were favorable to big banks. Even media coverage described these changes as a major win for the largest US banks.

As such, the powerful banking lobby prompted regulators to make a number of important changes that have led to a less safe banking system and greater opacity.

The recent change that will allow banks to hide bad loans is another major blow to system stability and to depositors. That said, while these changes make banks’ financial statements less transparent, they can’t hide these loans forever. It is only a matter of time before they are unable to extend bad loans.

Obviously, we believe this is yet another reminder not to rely on banking regulators to protect your deposits, because, as we see, they are under significant pressure from a very powerful banking lobby.

Bottom line

Believe it or not, there are more major issues on the larger bank balance sheets as compared to smaller banks, which we have covered in past articles. Moreover, consider that there was one major issue which caused the GFC back in 2008, whereas today, we currently have many more large issues on bank balance sheets. These risk factors include major issues in commercial real estate, rising risks in consumer debt (approaching 2007 levels), underwater long-term securities, over-the-counter derivatives, high-risk shadow banking (the lending for which has exploded), and elevated default risk in commercial and industrial (C&I) lending. So, in our opinion, the current banking environment presents even greater risks than what we have seen during the 2008 GFC.

Almost all the banks that we have recommended to our clients are community banks, which do not have any of the issues we have been outlining over the last several years. Of course, we're not saying that all community banks are good. There are a lot of small community banks that are much weaker than larger banks. That’s why it's absolutely imperative to engage in a thorough due diligence to find a safer bank for your hard-earned money. And what we have found is that there are still some very solid and safe community banks with conservative business models.

So, I want to take this opportunity to remind you that we have reviewed many larger banks in our public articles. But I must warn you: The substance of that analysis is not looking too good for the future of the larger banks in the United States, and you can read about them in the prior articles we have written.

Moreover, if you believe that the banking issues have been addressed, I think that New York Community Bank is reminding us that we have likely only seen the tip of the iceberg. We were also able to identify the exact reasons in a public article which caused SVB to fail. And I can assure you that they have not been resolved. It's now only a matter of time before the rest of the market begins to take notice. By then, it will likely be too late for many bank deposit holders.

At the end of the day, we're speaking of protecting your hard-earned money. Therefore, it behooves you to engage in due diligence regarding the banks which currently house your money.

You have a responsibility to yourself and your family to make sure your money resides in only the safest of institutions. And if you're relying on the FDIC, I suggest you read our prior articles, which outline why such reliance will not be as prudent as you may believe in the coming years, with one of the main reasons being the banking industry’s desired move towards bail-ins. (And, if you do not know what a bail-in is, I suggest you read our prior articles.)

It's time for you to do a deep dive on the banks that house your hard-earned money in order to determine whether your bank is truly solid or not. You can feel free to review our due diligence methodology here.

Avi Gilburt is founder of ElliottWaveTrader.net and SaferBankingResearch.com.