Since 1992, the banking sector's average return on assets has easily topped the 1 percent benchmark that banking analysts apply to individual institutions as an indicator of healthy earnings. Recently, however, several indicators have pointed toward emerging weakness. In addition, the yields on bank subordinated debt have risen relative to the yields on similarly rated corporate bonds, meaning that holders of sub debt perceive an increase in the likelihood of default. Finally, the business press has begun to note loan quality problems at large banks. 1 Problems in the banking sector are not just a concern for bankers.
Healthy banks are essential to the smooth operation of the economy.
Commercial banks enhance economic efficiency by channeling surplus funds from household savers to business investors. Banks also serve as a key link in the chain that runs from the Federal Reserve to the macroeconomy. The Fed changes the level of bank reserves by buying and selling Treasury securities in the open market. Banks respond to changes in the level of their reserves by expanding or contracting their loan portfolios. A weak banking sector can limit the impact of monetary policy actions on the supply of credit and hamper the ability of bank-dependent firms to get credit.