In Focus This Quarter

Indicators of Industry Performance--The reported financial condition of insured banks and thrifts is strong. However, despite projected growth in earnings, bank and thrift stocks underperformed the broader market through October 1999.

Economic Conditions--The economy remains generally strong, and the outlook calls for continued growth. Growth is likely to slow, however, in order to correct financial imbalances that have developed as a result of a rapid creation of household and commercial credit and borrowing from abroad. There is a threat that the adjustment process could be a volatile one.

Emerging Risks in Banking--Rising indebtedness on the part of businesses and households raises concerns about future loan performance. Industry responses to intense competition have created greater credit, market, and operational risks.

Consumer Lending--Banks and thrifts are becoming increasingly involved in subprime consumer lending, which has raised some supervisory concerns.

Commercial and Industrial Lending--Signs of deterioration in corporate credit quality can be found in rising loss rates, slower profit growth, and rising corporate bond defaults. At the same time, banks are expanding their lending to heavily indebted companies in the syndicated loan market.

Commercial Real Estate and Construction Lending--Loans for real estate construction and development are growing rapidly. Despite an uptick in commercial vacancy rates, loan losses remain low.

Agricultural Lending--Low commodity prices are hurting farm operating incomes, but widespread effects on farm banks have yet to materialize.

Funding and Interest Rate Risk--Lagging deposit growth has led to a greater reliance on more volatile, market-based funding, and some institutions are taking on greater interest rate risk to maintain loan growth.

By the Analysis Branch Staff

Regional Perspectives

Economic and Banking Conditions--Although the economy remains healthy, tight labor markets and weak demand have led to a slowdown in industrial output growth. Factors continuing to support the expansion include high levels of new construction, low inflation, and rapidly appreciating consumers' net worth. A sudden drop in the value of consumer assets, should one occur, could trigger a sharp and swift decline in households' discretionary spending. Sharply lower stock prices also could limit businesses' access to capital markets. The growing use of noninterest income and a changing asset mix during the first half of 1999 contributed to solid profitability levels and earnings performance at insured institutions.

Depressed Crop Prices Lead to a Decline in Farm Cash Receipts and Farmland Values--As farm cash receipts and farmland values decline, agricultural banks' asset quality measures are beginning to show signs of deterioration. A decline in the reserve coverage ratio could suggest that commercial banks have not made sufficient provisions for loan losses, which may affect the quality of future earnings.

Heightened Levels of New Bank Formation This Late in an Expansion Could Be Cause for Concern--The banking industry's record profitability during the 1990s has led to an increase in new bank charters. However, risky lending practices combined with declining earnings and growing use of noncore funding could be problematic for new institutions during an economic downturn.

By the Chicago Region Staff