The resilience of the global banking sector faces several tests. These include higher-for-longer interest rates, weak economic growth, property sector weakness, and high corporate and government sector leverage.
S&P Global Ratings credit analyst Gavin Gunning today (July 20) said: “Prudent funding and liquidity management will be integral to continuing ratings stability,” with findings based on S&P Global Ratings summaries for 83 banking jurisdictions, titled, “Global Banks Country-By-Country Midyear Outlook 2023: Resilience Will Be Tested”; its “Global Banks Midyear Outlook 2023: Resilience Will Be Tested”; and sector insights and trends, latest global and regional banking statistics and aggregate data in their “Global Banks Midyear Outlook 2023 Dashboard.”
U.S. regional bank defaults and the rescue of Credit Suisse shook confidence, but contagion risks have moderated.
Capitalisation and asset quality have strengthened over the past 10 years, and recent interest margins and profitability trends are positive. These factors will buffer banks in a downside scenario.
The reports showed that while bank buffers are more robust, maintaining the momentum of the past decade will be tough.
“Now that banks’ balance sheets are stronger, we anticipate that the regulatory focus will pivot even more in the direction of prominent emerging risks. These could include cyber risk, climate risk, and the speed of the movement of funds,” Gunning added.
The ratings giant found that although not their base case, risks of an economic recession in Europe and the U.S. is possible; inflation remains high; and the spillover from the Russia-Ukraine war continues.
Commercial real estate (CRE) markets are suffering a downturn, with demand and prices falling, especially in the U.S. and some European countries and expect bank rating outlooks to remain broadly stable (the net outlook ratio stood at 1% positive at midyear) due to solid capitalization and sound asset quality while anticipating increasing credit divergence.
Deterioration will be more acute for nonbank financial institutions and entities with weak funding profiles.
High corporate and government sector leverage will exacerbate corporate insolvencies and trigger potentially less government support for the real economy.
Digitalisation, climate change, and cyber to challenge banks’ business models and risk management Nontraditional risks add to the usual credit, market, funding, and operational risks. “
“A material downside emerges–including a full-blown recession with a sharp rise in unemployment. Property sector deteriorates more than expected Weakness in CRE markets accelerates, ultimately hurting banks’ asset quality. Banking sector contagion risks While risks have moderated, sound funding and liquidity will remain integral to ratings stability, they cited.
Higher-For-Longer Interest Rates Weigh On Economies
The macro picture remains weak for the remainder of 2023 and 2024, with low economic growth and high inflation in several countries. The main challenge for central banks is to rein in and re-anchor expectations without causing a recession. S&P believes that the ECB will seek to raise rates once again in July before pausing.
As economic growth remains low and financing conditions tight, we see a risk that high interest rates, persistent inflation, and consumer caution will push the U.S. and Europe into recession in the second half of 2023 or 2024.
Tighter Funding Conditions Means Higher Credit Risk
Elevated CRE refinancing costs and lower collateral valuations mean higher–but manageable–credit losses for many banks. A more extreme CRE stress could see downgrades for the most exposed banks.
Crypto Ecosystem Is Evolving
Blockchain technology promises a decentralisation of the financial system but most adoption so far has taken place through centralised finance (CeFi) intermediaries. The failure of several CeFi entities in 2022 highlighted risk management and governance issues, and the contagion risks between them.
Decentralised finance (DeFi) protocols largely weathered the storm, with minimal loan losses on the major collateralised lending platforms and the continued growth of decentralised exchanges.
Yet DeFi still carries risks, and the lack of a regulatory framework and know-your-client/antimoney-laundering functionality hinders its adoption by traditional financial institutions.
Artificial Intelligence To Empower Bank Business
AI could amplify banks’ competitiveness, profitability and risk management if well implemented as it offers full utilisation of untapped revenue potential with customers, simplify operations, reduce costs, and improve efficiency and earnings, achieve faster and more accurate decision making while enhance risk management practices along with improving customers’ financial wellbeing, literacy, and experience.
Bank Strategies To Address Climate Change
Reducing climate-related risks is a key priority for an increasing number of banks. Today, awareness and preparedness is gradually improving.
More climate-related data is available, and methodologies/models are progressing. Regulatory climate stress tests are developing rapidly across regions. While exclusion and divestment policies have the potential to rapidly reduce banks’ climate risk, customer engagement is gaining traction.
Banks are also increasingly committing to finance green projects and technologies. The energy transition offers large business opportunities for banks with the suite of “green” products and services offered broadening like in the cases of green mortgages, electrical vehicle loans.
Tight financing conditions under a higher interest rate, environment Geopolitical tensions and difficult domestic socio-political conditions erode credit fundamentals. With this said, there are a few bright spots.
Emerging Markets – Lingering Tighter Financing Conditions
High interest rates and subdued economic activity will pressure some Emerging Markets (EMs).
While inflation has peaked across most EMs, higher-for-longer domestic and global interest rates are reducing credit growth and affecting sovereigns, corporates, and households. Coupled with weakening demand, this could erode corporate profits, households’ purchasing power, and banks’ asset quality.
Domestic Demand, Inflation Relief Support Asia-Pacific’s Outlook
Evolving risks – A desynchronised global economy in terms of growth, inflation and policy interest rate trends is complicating the region’s credit outlook.
The key export market of the U.S. seems headed for a soft economic landing.
High rates – With interest rates and inflation set to stay high for longer (except China), borrowers and customers are increasingly accustomed to higher financing costs and prices. S&P therefore see risk around access to financing as high and unchanged.
Slower exports – The ratings house assesses the risk of a hard landing for the global economy as being high and unchanged. While weaker global demand will slow export and manufacturing activities, the resumption of social mobility and consumption across the region will offset the drag.
Under these situations, S&P has lowered Asia-Pacific’s GDP growth marginally to 4.5% in 2023 and 2024.
China dims – China’s recovery momentum post-COVID is ebbing, waylaid by weak business and household confidence. High youth unemployment and lingering property weakness further sour sentiment. The introduction of policy stimulus could limit the slowdown in growth.
At present, 75% of bank ratings globally are on stable outlook. Higher interest rates have generally benefited banks’ net interest margins although the effect on bank profitability will be mixed. High corporate leverage could also cause more corporate insolvencies.
“Higher-for-longer-than-anticipated interest rates against an already-high leverage backdrop is a key risk for banks,” said S&P Global Ratings credit analyst Emmanuel Volland adding, its forecasted that US$772 billion in credit losses for global banks may be incurred which represents a 15.7% increase compared with 2022.
We anticipate negative ratings momentum in a recessionary downside scenario materially outside our base case.
“Far from being an even playing field globally, the property sector is also increasingly vulnerable given the outlook of high interest rates and low economic growth,” said S&P Global Ratings credit analyst Alexandre Birry.
