Strong bank balance sheets built up in the past decade will be put to the test in 2023, as global banks confront toughening conditions. Besides higher inflation and lower economic growth, banks and their customers are also facing property-sector weaknesses in many jurisdictions said S&P in its latest Global Bank Outlook report.
“Global banks have on average doubled their regulatory capital in the past 10 years. This will offer them some resilience against rising stress for borrowers,” said S&P Global Ratings credit analyst Gavin Gunning. Robust capitalisation, along with still-sound asset quality and an earnings boost from higher net interest margins, continues to underpin our overall stable view across the global banking sector.
However, if macro conditions deteriorated beyond our base case, capital cushions could start deflating.
“A key risk to bank ratings is the emergence of harsher economic and financing conditions than our base case,” said Mr. Gunning. “Additional key risks are potentially higher corporate insolvencies exacerbated by high corporate leverage, high government leverage, and weaker property sectors.”
Many corporate borrowers are stretched, after several years of pandemic and related strains. Default rates have edged up compared with the same period last year, as issuers contend with the highest interest rates in decades.
Banks initially benefit from tighter monetary policy, which feeds through to wider net interest margins. Still, the muted economic backdrop and stress on borrowers can lower loan growth and increase nonperforming loans.
Higher rates might lead some banks to avoid calling their hybrid capital issuances, as investors generally expect the banks to do when they purchase the instruments. Not calling would allow banks to carry on with lower rates, rather than reissuing at higher funding costs.
This might make waves in the market; however, in our view, such decisions are unsurprising and would likely be driven by rational economic behavior in many cases–i.e., locking in cheaper coupons than what could be obtained on a new instrument–rather than capital challenges or credit weakness.
“We anticipate increasing credit divergence,” said S&P Global Ratings credit analyst Emmanuel Volland. “Deterioration will be more acute for emerging market banks, nonbank financial institutions, and entities in countries most exposed to energy restrictions.”
Tightening financing conditions, a strong U.S. dollar, slower growth in China, and a potential recession in the U.S. and Europe signal tougher times ahead for emerging markets.
Weaker economic and financing conditions in 2023 will likely hit earlier and harder for nonbank financial institutions (NBFIs). NBFIs typically have less-diversified business profiles compared with banks, tend to be more reliant on market funding, and often don’t benefit from central bank access.
From a macro perspective, we are cautious about the nonbank sectors taking a progressively larger share. As bank regulations have tightened over the past decade, unregulated or less regulated NBFIs have gained market share.
“Sound funding and liquidity management by banks are integral to continuing ratings stability in 2023,” said S&P Global Ratings credit analyst Alexandre Birry.
Information flow and funds transmission across the global financial system is lightning fast; global banks are highly interconnected with other banks and sophisticated counterparties; and in times of significant stress, markets can be unforgiving discriminators between institutions.
“Funding and liquidity have the potential to be an immediate ratings differentiator for negative outliers in 2023,” Mr. Birry added.
