The recent Q2 results of the largest US banks were treated almost like a cult event by mainstream media and most analysts. A lot of bold things were said - spectacular earnings, the strongest quarter in history, confirmation that the US banking sector is stronger than ever, and more along those lines.
Yes, capital-markets businesses had an exceptional quarter - SpaceX IPO activity, M&A, equity trading. However, a deeper look at the numbers reveals a rather different story. The earnings beats at the largest capital-markets-heavy banks like JPM, BAC, MS and GS were disproportionately driven by capital markets, rather than core banking businesses. And this is a huge difference.
The clearest example is JPM. Q2 revenue was up 27% YoY, but that includes significant one-off gains; excluding those, revenue was up about 15%. Markets revenue jumped 35%, with Equities up 86%. By contrast, net interest income excluding Markets was only +4% YoY. So, the spectacular headline quarter looks much less spectacular once you strip out markets and exceptional items.
BAC is similar, though somewhat less extreme. Total revenue rose 15% YoY, while sales & trading revenue was +33%, including an extraordinary +70% in Equities. Global Markets pretax income increased from $2.15B to $3.55B. But NII was up 9%.
MS tells a similar story. Total net revenue was up 27% YoY, but Institutional Securities revenue jumped from $7.6B to $11.0B, with Equities up 69% and Investment Banking up 58%. Wealth Management revenue was also strong, but grew a much less spectacular 14%.
And GS is basically the purest expression of this point. Global Banking & Markets revenue rose 53% YoY; Equities +72%, FICC +32%, and investment-banking fees +55%.
In other words, recent earnings strength at the largest US banks has been disproportionately driven by trading and investment banking, while growth in the more recurring parts of their businesses has been materially slower. And this matters because banks are currently operating in a very benign environment, while the huge wave of deregulation, which we discussed in one of our previous articles, provides another major tailwind.
Additionally, it is very important to recall two Fed studies which have recently been published and were also discussed in our articles.
The great majority of the public believes that larger banks are in a much better financial position than they were before the GFC. And confidence in these banks seems quite ubiquitous. However, these Fed studies suggest just the opposite is true.
The first study concluded that post-GFC prudential reforms aimed at large banks have not reduced solvency risk. In particular, post-crisis prudential changes for larger banks do not appear to have produced materially lower solvency risk, either over time or relative to smaller banks. Importantly, deposit-funding risk at larger banks has risen significantly as these firms have increased their reliance on uninsured deposits.
In the second study, the Fed examined all failed banks between 1997 and 2025. The resulting sample of 465 failed banks is dominated by failures during the GFC, as roughly two-thirds of the failures occurred from 2008 to 2010. The regulator compared four measures: its baseline economic capital measure (EC), R-EC (economic capital under a “run scenario,” where the Fed assumes that uninsured deposits must be replaced with market-rate funding that is more expensive than deposits), TCE (tangible common equity), and TCE adjusted for estimated losses on loans and securities (MTM TCE). Each measure is scaled by total bank assets to create a leverage-ratio-type metric. Unsurprisingly, R-EC is more accurate than the alternative solvency metrics.
Taken together, the first study showed that large US banks have weaker economic capital compared with 2007, and the second study showed that economic capital better predicts bank failures than the classic capital ratio used in the Fed’s stress tests. The takeaway from these studies is very simple: large banks are now more likely to fail than before the GFC. This effectively ends the argument of those who still believe that large banks are better prepared for a crisis than they were in 2007. Add to that the fact that, even in today’s benign environment, the spectacular part of recent earnings growth is coming largely from capital markets, and it raises a pretty obvious question: how strong are normalized earnings once these tailwinds fade?
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