Moody's: US bank balance sheets strong, but low interest rates and competition pressure profitability

The improving economy will help bolster the asset quality of US banks through 2016, but margin pressure stemming from low interest rates and intense competition amongst banks and from the large non-bank sector will keep bank creditworthiness stable over the next 12-18 months, says Moody's Investors Service.

GDP growth, low oil prices and rising employment will continue to support the already strong asset quality of US banks. And while Moody's does not expect asset quality to erode materially within the outlook period, below-average profitability and enhanced capital and liquidity requirements will make it challenging for banks to cover their cost of capital, according to the report "Banking System Outlook: United States of America."

Low interest rates have intensified competition with the non-bank (shadow banking) sector, and the implications of this competition could ultimately lead to a deterioration in asset quality.

"The search for yield has led banks and shadow banks to relax underwriting standards," says Allen H. Tischler, a Moody's Senior Vice President. "We have been highlighting this trend, but it is otherwise unnoticeable in banks' strong asset quality metrics. However, when interest rates rise, banks will hold a larger share of higher-risk loans on their balance sheets, particularly when economic growth slows."

Moody's also notes that US banks have strong liquidity profiles thanks to their large deposit bases and ready access to secured funding from the Federal Home Loan Bank system.