Financial intermediation is the process of matching savers, who are willing to lend funds to earn a future rate of return, with borrowers, who are presently in need of funds to make transactions. It is expensive for savers to locate, underwrite, and monitor repayment behavior of borrowers. Similarly, it is expensive for borrowers to locate a sufficient amount of savers with funds and favorable lending terms. Hence, banks develop expertise in intermediation , or facilitating the transfer of funds from savers to borrowers. Although other institutions (e.g., credit unions, insurance companies, pension funds, hedge funds) also engage in the financial intermediation matching process, this report examines how depository banks are faring in this activity. A commercial or depository bank is typically a corporation that obtains either a federal or state charter to accept federally insured deposits and pay interest to depositors; make residential and commercial mortgage loans; provide check cashing and clearing services; and may underwrite securities that include U.S. Treasuries, municipal bonds, Fannie Mae and Freddie Mac issuances, and commercial paper (unsecured short-term loans to cover short-term liquidity needs). The permissible activities of depository banks are defined by statute. The typical intermediation transaction made by banks consists of providing loans to borrowers at higher rates than the cost to borrow the funds from savers, who provide loanable funds in the form of bank deposits. Banks profit from the spread between the rates they receive from borrowers and the rates they pay to depositors. Facilitation of the intermediation transaction involves risk. Banks face the risk that borrowers can default on their loans, making it more difficult to repay depositors. In addition, banks face funding or liquidity risk stemming from more frequent movements in short-term interest rates. Banks must have access to an uninterrupted source of short-term funding (deposits) until their long-term loans are fully repaid, which is explained in more detail later in this report, and fluctuations in short rates translates into fluctuations in their profit spreads. Furthermore, depositors could suddenly and simultaneously decide to withdraw their deposits, perhaps due to a sudden change in economic conditions or even speculation about deteriorating economic conditions, resulting in financial distress for a bank or several banks. Hence, bank profitability and financial risk are inextricably linked. In addition to default and funding risks, financial intermediation increases the vulnerability of borrowers to economic downturns. During business cycle booms, lenders may grow optimistic and increase credit availability as if the ideal economic and financial market conditions will persist. The trade-off or costs associated with an expansion of lending is a corresponding rise in the severity of financial distress should economic conditions suddenly deteriorate. In other words, recessions that occur when individuals have more loan repayment obligations (or are more leveraged financially) are likely to be more arduous, in particular if these individuals (via job losses or pay cuts) suddenly face lower income prospects. U.S. depository banks are required to comply with safety and soundness regulations, which are designed to monitor and buffer against the types of financial intermediation risks that can result in financial distress for banks and the broader economy. The propagation of intermediation risks is curbed when lending activity is restrained, but there is a cost associated with a reduction of financial risk. Recessions are likely to be milder when fewer loan repayment obligations are outstanding, but the trade-off is a less robust economic expansion. Fewer loans translate into fewer transactions that could possibly have spurred greater economic activity. Consequently, determining how much financial intermediation risk is optimal for the banking system to take while simultaneously trying not to undermine economically stimulative lending activity is often a regulatory challenge. Congressional interest in the financial conditions of depository banks, also referred to as the commercial banking system, has increased following a challenging economic and regulatory environment. The conditions of the banking industry can be examined in terms of profitability, lending activity, and capitalization levels (to buffer against the financial risks); but this report focuses primarily on profitability and lending activity levels. Particular attention will be paid to metrics related to asset performance and earnings of depository banks. These measures show that profitability for the banking industry has improved, but the rate of lending activity has not returned to pre-crisis levels. This report discusses the depository (commercial) banking institutions as having one aggregate balance sheet to facilitate the analysis. The following balance sheet terminology is used. Bank assets include long-term consumer, residential, and commercial loans that banks originate as well as cash and other financial securities that they hold in their asset portfolios. Bank assets will generate earnings (revenues) or losses, depending upon whether customers repay or default on their loans. Bank liabilities include the funds that they borrow. When customers (depositors) make savings or checking deposits into a bank, the bank is essentially borrowing those funds for short periods of time in order to lend them out for longer periods of time. The interest paid for these borrowings are, therefore, the costs incurred by the bank to obtain the funds necessary to originate new loans. Bank capital is the difference between the value of assets and liabilities. Bank capital includes items such as common shareholder equity, retained earnings, and provisions set aside for loan and lease losses (discussed in more detail below). Banks that accept federally insured deposits are required to maintain sufficient capital reserves to protect bank creditors from loan defaults by bank customers. Asset (loan) defaults are less likely to result in failure of a bank to repay its shorter-term obligations if sufficient capital is maintained to absorb the losses. If, however, a bank's capital falls below minimum regulatory threshold levels, it would be considered undercapitalized and faces the prospect of being shut down by its regulator, which typically appoints the Federal Deposit Insurance Company (FDIC) as the receiver of the insolvent institution. Consequently, compliance with regulatory capital requirements implies that capital reserves must grow proportionately with bank asset (lending) portfolios. Assets in the banking industry are not evenly distributed, which means that banking firms are not identical and, for some metrics, must be analyzed separately to get a more accurate assessment of financial conditions. Using data from the FDIC, Figure 1 illustrates the number of U.S. banks over time by the following size categories of bank asset holdings (defined below): less than $100 million, $100 million-$1 billion, $1 billion-$10 billion, and greater than $10 billion. Community banks are commonly defined as financial institutions with total assets below $1 billion. At the other extreme are the large financial institutions that have $10 billion or more in assets. The number of banks with more than $10 billion in assets has remained relatively constant, ranging from 95 to 108 institutions over the period. Figure 1 also shows the dollar amount of bank assets in millions of dollars. As of 2013, the FDIC reports that industry assets were $14,722.80 billion. For several decades, bank assets have increased while the number of banking institutions has declined. The smallest of the community banks, those with less than $100 million and collectively holding approximately 1% of all industry assets, have accounted for most of the industry consolidation even prior to the 2007-2009 recession. Banks with more than $10 billion in assets collectively hold approximately 80% of all industry assets. Consequently, profitability and lending activities may differ by bank size. The banking system recently saw unusually high numbers of distressed institutions, with failures at rates not seen since the savings and loan crisis that began in 1980 and lasted through the early 1990s. The number of banks that failed, or fell substantially below their minimum capital reserve requirements, increased as the financial crisis of 2008 unfolded. No banks failed in 2005 and 2006, and three bank failures occurred in 2007. In contrast, the FDIC administered 25 bank failures in 2008, 140 bank failures in 2009, and 157 bank failures in 2010. The bank failure rate has since diminished with 92 bank failures in 2011, 51 bank failures in 2012, and 24 bank failures in 2013. Of the 6,812 FDIC-insured institutions in 2013, the FDIC reports that approximately 35% reported negative quarterly income at various quarters after the financial crisis; the percentage of these unprofitable institutions fell to 12.2% by the fourth quarter of 2013 from 15% in the fourth quarter of 2012. The FDIC also maintains a problem list of banks at risk of failure because their capital reserves have fallen below regulatory minimum levels (but perhaps not yet far enough below to be shut down). The number of depository institutions on the FDIC's problem list rose from 52 banks in 2005, peaked at 888 in the first quarter of 2011, before falling to 467 by the end of 2013. Figure 2 shows the number of FDIC-insured banks, the number of problem banks, and the number of unprofitable institutions by quarter since 2005. Note that an unprofitable institution may not be counted on the FDIC's problem institution list if it has enough capital to absorb its quarterly revenue shortfalls and still meet the adequately capitalized or well-capitalized thresholds. The industry has returned to profitability. The FDIC reports that industry full-year net income rose to $154.7 billion in 2013, representing the highest net income level since 2006. Although lending growth has increased, the FDIC reports that most of the earnings increase can be attributed to increases in noninterest (fee) income and lower provisions set aside for anticipated loan losses, discussed in more detail below. Return on assets (RoA) and return on equity (RoE) are commonly used metrics to gauge bank profitability. RoA is computed with net income (total assets minus total liabilities) in the numerator and average total assets in the denominator. The RoA measures the financial return of a bank's average assets or lending activities.