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76 Fed. Res. Bull. 477 (1990)
Developments Affecting the Profitability of Commercial Banks

handle is hein.journals/fedred76 and id is 1043 raw text is: Developments Affecting the Profitability of Commercial Banks John V. Duca and Mary M. McLaughlin, of the Board's Division of Monetary Affairs, prepared this article. Douglas Carpenter and Vernon McKinley provided research assistance. In 1989, the profitability of U.S.-chartered in- sured commercial banks declined after having rebounded in 1988. In recent years, variations in loss provisioning have accounted for variations in profits; abstracting loss provisions, net income has been quite stable as a share of assets. Last year, another surge in loan loss provisions, con- centrated at large banks with substantial loans to developing countries, pulled down the industry's return on assets to 0.51 percent, the second lowest level since 1970 (chart 1), and its return on equity to 7.94 percent. Despite the decline in profitability, dividends paid as a share of assets continued at high levels, reducing retained earn- ings to very low levels. In the aggregate, the primary capital ratio of banks decreased, but most of the decline was at money center banks, which dipped into capital to pay dividends. Banks increased loss provisions more than net charge-offs and ended the year with somewhat higher loan loss reserves (chart 2). After peaking early in 1989, short-term interest rates declined from the spring through the end of the year as the Federal Reserve took steps to sustain economic growth (chart 3). Nevertheless, by the end of 1989, short-term market rates were still well above their 1988 averages. Reflecting the higher average level of rates, interest expense as a share of assets rose about I percentage point. Increases in delinquent loans restrained the pickup in the rate of return on banks' loan portfolios stemming from higher market rates. As a result, the spread between interest income and interest expense (net interest margin) narrowed slightly, although it remained above the average of recent years (table 1). On a year-end basis, overall growth of interest- earning assets at U.S. banks picked up to a moderate rate, reflecting mainly stronger expan- sion of bank holdings of securities (table 2). Bank loan growth was near the pace of 1988 as reduced runoffs in foreign loans and a turnaround in security loans roughly offset a moderation of growth in consumer loans and domestic commer- cial and industrial (C&I) loans. Much of the slowing in business loans to domestic addressees occurred in lending that was unrelated to merg- ers. Growth in consumer loans held by banks was reduced by the issuance of securities backed by consumer loan receivables, a transaction that removes loans from bank balance sheets. By

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