We have a positive outlook on the diversified banks sub-industry, as we expect consumer and commercial loan activity to moderate but remain positive. Unlike most industries, banks also benefit from the Federal Reserve’s rate rise regime with higher net interest income, notes Kenneth Leon, analyst at CFRA Research.
Banks successfully handled credit risks, but we think loan loss reserves are reverting higher to normalized levels. The US economy is likely to be a key driver of bank performance in 2023, and the Ukraine-Russia war creates extended uncertainty for global banks.
Consumer loan activity has been improving but is still below prepandemic levels. In March 2020, bank consumer loans peaked at $859 billion and then declined to a low of $743 billion in April 2021. The December 2021 bank consumer loan balances were just under $800 billion.
Regarding demand for consumer loans, banks reported weaker demand for auto, mortgage, personal, and credit card loans in 2022, with lower expected growth in 2023. In March 2023, Fed-watching took a dramatic turn away from monetary policy to the financial stability of the US banking system.
As such, the Fed’s Supervision and Regulation organization released its findings on the failures of Silicon Valley Bank and Signature Bank in late April 2023. In addition, Vice Chairman Michael Barr has been steadfast in increasing the Fed’s supervision for banks.
A July 2023 speech by Mr. Barr points to raising the capital buffers for banks with $100 billion or more in total assets versus the current $250 billion threshold. He believes credit risk is directly tied to liquidity risk, thus both areas have to be better regulated in future years.
Return of capital from the Fed’s Dodd-Frank Stress Test results helps large banks keep a higher capital buffer. Any changes to the stress test are likely to be complementary to the changes in the risk-based capital framework to reflect credit, trading, and operational risk.
There are no expected changes to the supplementary leverage ratio (SLR), the global systemically important bank (G-SIB) surcharge, or the countercyclical capital buffer (CCyB) cited in the July speech, called “Holistic Capital Review.”
During the July 25-26 FOMC meeting, the Fed decided to raise the target range for the federal funds rate by 25 bps to 5.25%-5.50%. Monthly quantitative tightening (QT) of the Fed’s balance sheet, with $35 billion in mortgage-backed securities and $60 billion in US Treasury bonds began in June 2022.
The banking crisis in March 2023 may have delayed reaching QT goals, as the Fed increased its available borrowings to banks to over $300 billion to arrest a bank panic and reach financial stability. QT is part of the Fed’s monetary policy to return inflation to its 2% mandate.