Why banks are setting aside cash to cover bad loans
There’s a special feeling you get during this time of year. The air gets cooler, the leaves change color, and companies issue their latest quarterly reports. Yes, we are in the middle of earnings season. And lately, we’ve been hearing from a number of companies that are preparing for a chillier economy. Call it hoarding their acorns.
Tuesday morning, Goldman Sachs said it’s setting aside more cash to cover bad loans, compared to the same time a year ago. Over the last few days, several other banks said they’re doing the same thing, including Bank of America, JPMorgan Chase and Wells Fargo.
When the economy starts looking scary, bank executives have to make a judgment call about their outstanding loans.
“What does management think is the likelihood that all of those loans that they’re carrying on their balance sheets are actually going to be paid off?” said Kathryn Judge, a law professor at Columbia.
The idea, she said, is to set aside cash now in case borrowers default later.
In fact, this is what banks did when the pandemic first started.
“And that was because there was this huge shock to the economy, and they didn’t know exactly what the effect was going to be,” Judge said. “But all of them actually thought this is really going to hurt our borrowers. It’s going to hurt households, it’s going to hurt businesses.”
But the economy looks a lot better today than it did in early 2020.
Gerard Cassidy, a bank analyst at RBC Capital Markets, said right now, people generally aren’t having problems paying back their debt.
“In fact, the current credit picture for the industry is very robust, both on the consumer side and commercial side,” he said.
That could change if there’s a recession. People could lose their jobs and have trouble paying off bills. Companies could lose sales and have trouble servicing their debt.
Karen Petrou at Federal Financial Analytics said banks are essentially pulling out their sweaters ahead of the winter.
“We might not need them, maybe the winter will be warmer than we think, but we have the sweaters, we bought the sweaters, we’re ready,” she said.
And if there’s a mild recession, or no recession, Petrou said it’s no big deal to put those sweaters back.