Each depositor insured to at least $250,000 per insured bank


During the FDIC's Quarterly Banking Report press briefing held on September 20, there were several questions that sought to discern how the banking industry was likely to respond to the events of September 11. We subsequently conducted a review of changes in bank assets, deposits, loans and income after previous military and political crises. The following article, "How the Banking Industry has Responded to Crisis" is the result of that review.


In recent times, the banking industry has experienced unprecedented prosperity. However, an economic slowdown that began in late 2000, and gained momentum during 2001, appears to be accelerating following the attacks on September 11. The question arises how banks will fare in this new environment. An examination of banks' past performance during times of adversity may provide some insight about what to expect. This report broadly reviews the current and historical condition of the commercial banking industry to provide some context for an assessment of its strength as it faces the uncertainties that lie ahead. It also reviews past responses of banks when they encountered other crises and periods of strong uncertainty. The data analyzed in this report provide evidence that, by some key measures, the industry is currently stronger than it has been over the last 50 years. Also, analysis of the historical data shows that, notwithstanding difficulties experienced by specific banks or groups of banks, the industry, as a whole, was able to expand credit and provide a safe haven for insured depositors. As in the past, the industry is expected to follow its usual pattern of lagged tracking of the overall economy.

Currently, banks enjoy the benefits of more than a decade of growth, diversification and technical innovation. This progress, largely associated with years of favorable business environment, has strengthened the industry significantly. Chart One illustrates how, during the past decade and longer, the industry has enhanced its three principal lines of defense against financial problems. Those defenses are earnings, backed up by reserves against loan defaults and anchored by the owners' stake in the continued success of the enterprise. Over the past several years, net income has increased, more loan loss reserves have been put in place and bank equity has grown -- at a faster rate than the industry's asset base has increased. In addition, noncurrent loans have remained at modest percentages of assets since the early 1990s and, even though they have increased in recent years, are still low in comparison to levels that occurred during the most recent crises. It should be noted that, while the industry responded to past crises with real growth, some of those crises were nevertheless accompanied by increased numbers of troubled banks. Similarly, despite the current strength of aggregate industry indicators, risk exposures of individual banks vary significantly, and not all institutions are equally well positioned to cope with adversity.

Net Income, Reserves and Capital Cushions Are at Historically High Levels

The banking industry has also undergone significant geographical diversification during the past decade, making it far less vulnerable to events or conditions in one part of the nation. This increased diversification of products and markets should help buffer the most severe effects of a slowing economy. Chart Two illustrates this trend. With the end of most limits on interstate branching during the 1990s, we now have 488 banking companies, representing $5.8 trillion (76%) of industry assets, with office networks in multiple states. Many of these institutions operate from an array of interstate offices, making loans, collecting deposits and managing assets across wide spans of the country. Current spreading of geographic risk contrasts with a far less diversified industry in times as recent as the mid 1980s. For example, in 1985, only 107 banking companies, accounting for $1.02 trillion (35%) of commercial bank assets, operated offices in more than one state.

The Industry Has Become More Geographically Diversified

Banks, particularly larger banks, have developed considerable sources of income beyond lending and are not nearly as dependent on interest income as in former times. Fee income from a variety of sources constitutes a much larger portion of operating income. Some of the growth in noninterest income has occurred in market-sensitive categories such as trading revenues, which can be expected to become more volatile during periods of economic weakness or uncertainty. Fee income, in particular, has suffered from recent market disruptions, and is sensitive to some extent to slowing loan growth. However, other revenues that are obtained from transaction-related services may prove to be less vulnerable to cyclical pressures, and could help support banks' earnings in the event of a downturn. The evolution of this type of business risk diversification is shown in Chart Three.

Banks Have Become Less Dependent on Interest Income

These trends suggest that the banking industry is more capable of withstanding economic stress than it was in most previous eras. In fact, by some key measures, it may be as strong or stronger than it has been at any time in history. Previously, banks have not been so well positioned when surprise events have clouded the future. For example, when the Japanese struck Pearl Harbor in 1941, our nation was still enduring the Great Depression. Nonetheless, as the following table shows, during the subsequent years of World War II, the industry continued to grow and it remained modestly profitable. While the banking industry's return on assets then was anemic in comparison with both today's standards and the 66-year average spanning the years 1934 to 2000, it is interesting to note that war did not render the industry unprofitable. Another difference between the industry's performance during the war period and times following most of the later crises, was the slow rate of loan growth during the early 1940s. This lending slack resulted because few items other than those required for the war effort were made, while production capability for most military-related goods was government financed.

Response of Commercial Banking Industry to Selected Historical Crises

The responses of the commercial banking industry to subsequent crises, including the North Korean and Chinese invasions of South Korea in 1950, the Cuban Missile Crisis of 1962, President Kennedy's assassination in 1963, the Arab oil embargo of 1973, President Nixon's resignation in 1974, the stock market crash of 1987, the Liberation of Kuwait (Operation Desert Storm) in 1991, the attempted coup in the Soviet Union, also in 1991, and the Asian economic crisis of 1997, are also chronicled in the table2. Note that, even in years such as 1991, when more than one event occurred that caused great uncertainty and the banking industry was already in a severe downturn, there was still positive real growth in loans over the ensuing three-year period. In addition, even when viewed in the context of the consumer price index, significant asset and deposit contractions did not occur. It is also noteworthy that the lending decline of 1991, which some observers cited as evidence of a "credit crunch' and others attributed to recessionary lack of demand, was followed by three years of growth well in excess of the consumer price index.

The data also show that the industry's average return on assets during the crisis years (0.71 percent) was only modestly lower than its long-term average (0.76 percent). However, in the three-year period following the crises, profitability recovered to 0.80 percent, a level better than the long-term industry average. Also noteworthy is that the lowest return on assets depicted in the table (0.09 percent in 1987) resulted from events unconnected with any of the crises. The dismal return on assets that the industry earned that year, based largely on losses reported in the first quarter (well before the stock market crash), was a consequence of widespread loan loss provisions for third world and emerging country loans at a few of the largest banks. That debacle, followed by several years of substandard performance, as banks suffered from a bursting real estate bubble and a variety of other background economic adversities, provides specific evidence that financial conditions have considerably more impact on the banking industry than crisis events by themselves. This evidence is underscored by the strong increase in industry profitability following subsequent crises. In fact, in the three-year period after the Persian Gulf War, bank earnings averaged 1.09 percent of assets. Profitability has not declined below this value since then.

We compare the industry's growth during and immediately following several crises with growth attributable to inflation, as measured by the consumer price index, over the past 66 years. In five of the nine crisis years shown in the table, banking industry assets and deposits grew more rapidly than the inflation rate. Loan growth exceeded inflation during all but two of the crisis years. Instances when measures of industry growth fell short of inflation are indicated by the asterisked entries of the table. The industry's average growth during crisis years also exceeded the average inflation rate. [Average annual asset growth was 7.03 percent; average annual deposit growth was 6.16 percent; average annual loan growth was 10.75 percent -- vs. average consumer price index (CPI) growth of 4.00 percent per year.] In five of the nine three-year periods following each crisis year, assets, deposits and loans all increased faster than inflation. Moreover, in all but one of the other three-year periods, growth in at least one of these measures exceeded the inflation rate.

Most of the instances when CPI growth exceeded industry growth were either recessionary or occurred close to postwar recessions, periods when loan demand normally slackens. For example, the recession period from November 1973 through March 1975 followed the onset of the Arab oil embargo in October 1973 and included President Nixon's resignation in August 1974. The recession from July 1990 through March 1991 spanned Operation Desert Storm which extended from January 16 to February 27. In short, during and following crises, the banking industry responded to credit needs and, typically, resumed real growth.

These examples are especially illustrative because they demonstrate that the underlying condition of the economy is a more important driver of the banking system's strength than severe crisis events or periods of great uncertainty. In fact, the uncertain condition of the economy, exacerbated by the attack's potential impact on consumer confidence - up until now the principal mainstay of continuing modest economic growth - is a strong concern. Particular differences between the current crisis and most of those preceding include high costs to the airline, hospitality and insurance industries. Other differences include heightened potential for ripple and reflective effects involving foreign markets and economies affected by weakness in the U.S. These problems and other fallout, both from the slowdown of the economy before the attacks and from the damage they caused, could lengthen and deepen the current slowdown.

Nonetheless, the pattern in past business cycles has been a lag between the bottom of a recession and the subsequent peak of credit losses which has ranged from 12 to 15 months. Since the industry now enjoys a considerably more robust cushion of earnings, reserves and capital than it did when entering previous recessions, the effects of credit losses are likely to be better buffered than previously. While times ahead will bring greater economic challenges to banks, and the past is an imperfect guide to the future, the industry is well positioned as a whole to serve as a source of strength

Last Updated 10/18/2001 research@fdic.gov