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Bernanke weighing on bank profits

August 28, 2012: 1:12 PM ET

FDIC says banks in for more pain in low-interest rate environment.

FORTUNE -- For banks, it's getting harder and harder to earn a buck.

In the second quarter, U.S. bank profits fell $800 million from the first three months of the year, according a report released by the Federal Deposit Insurance Corp. on Tuesday. The drop in profits came despite a significant increase in lending, which jumped $102 billion in the second three months of the year, the second largest jump in any quarter since the start of the financial crisis.

But low-interest rates, driven by the Federal Reserve's efforts to stimulate the economy, mean that new loans are increasingly less profitable, crimping bank profits. And that's not likely to end any time soon. The Fed says it expects to keep short-term interest rates "exceptionally low" through 2014. But many economists predict the Fed will soon extend its low-interest-rate pledge through the end of 2015.

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Already some banks are finding it tough to survive. In August, low-interest rates forced Hudson City Bancorp (HCBK), one of the few banks able to turn a profit during the financial crisis, to sell out to rival M&T Bank (MTB).

Still, the banking sector continued to heal from the financial crisis. The number of banks that the FDIC says are in jeopardy of failing dropped to 732. That list had once neared 1,000. What's more, the number of banks that failed in the quarter dropped to 15. That was the lowest failure rate in three and a half years. In all, 40 banks have failed since the beginning of 2012, down from 68 at this time a year ago.

Overall, bank earnings were still a hefty $34.5 billion in the second quarter. That was up from $28.5 billion in the same quarter a year ago. What's more, the quarter included a huge drop in trading revenues, driven in large part by missteps by JPMorgan Chase's (JPM) so-called London Whale, which resulted in the bank taking $4.4 billion loss on credit derivatives bets in the quarter. Without that, bank profits would have been better overall, though it's not clear how much.

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Still, FDIC officials said much of the profit boost from a year ago came from banks putting less money aside for future loan losses, and not from an improvement in their actual business. Revenue growth from lending and other bank activities continues to be stalled.

"There's only so far that can take you," says FDIC Acting Chairman Martin J. Gruenberg. "The rate environment is putting a constraint on the bank revenue growth."

The question is how banks will respond. Fed Chairman Ben Bernanke says one of his main reasons for his policy to push down interest rates is to boost lending. But it's not clear Bernanke's latest plan will make banks want to lend more.

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Instead, falling profits, driven by low-interest rates, could cause banks to lend less, particularly at a time when they are still trying to build back the capital they lost during the financial crisis. On the other hand, some banks may decide they have to dramatically boost lending in order to keep up profit growth at a time when they are making less and less on each individual loan.

What's clear is that Bernanke is trying to thread an incredible small needle head. Let's hope he gets it right.

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About This Author
Stephen Gandel
Stephen Gandel

Stephen Gandel has covered Wall Street and investing for over 15 years. He joins Fortune from sister publication TIME, where he was a senior business writer and lead blogger for The Curious Capitalist. He has also held positions at Money and Crain's New York Business. Stephen is a four-time winner of the Henry R. Luce Award. His work has also been recognized by the National Association of Real Estate Editors, the New York State Society of CPA and the Association of Area Business Publications. He is a graduate of Washington University, and lives in Brooklyn with his wife and two children.

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