In the last thirty years, the banking industry has seen significant regulatory changes, new business development, and several business cycles. One quantitative metric that can summarize the complicated universe of events over that time is profitability.
The chart above shows return on equity for the banking industry. Return on equity, calculated as net income (profit) divided by average equity on an annualized quarterly basis, is one of the most important banking ratios as it standardizes the bottom line of the income statement with equity to create a profitability ratio that is comparable across time and between banks.
After calculating this standardized time series measurement of profitability for the industry from 1990 to 2018, a few stories emerge:
Looking holistically at the industry, it's easy to understand why 2008 was a banking crisis and why the 2001 recession was certainly not a banking crisis. It is always helpful to remember that not all recessions are the same. In fact, the post-crisis period has also shown that recoveries or the "new normal" can also be very different than expected.
Turning toward the future, the industry will likely see increased profitability due to the 2017 tax cuts. In terms of spotting the next recession, keep a watch on profitability, which dropped leading up to the three recessions in the last thirty years. While things will of course be different next time, not everything will be.