Profits at US banks have tumbled, their share prices are underperforming, and their leaders sound grim. However, long-term investors have found new sources of optimism. Compared with the overall equities market, bank shares have traded at lower multiples since the financial crisis. They have been punished as if investors expect any economic trouble to expose underlying problems.
Conversely, investors have run to stocks such as Amazon, Netflix, Apple and Microsoft, who have all benefited from social distancing and stay-at-home orders.
With vaccines unavailable until early 2021, vaccination at scale requiring many months, and wide-spread immunity lagging, growth will lag while income and employment will remain well below its pre-pandemic trend for quarters, if not years.
Consequently, the Federal Reserve has slashed interest rates and has said it expects to keep rates low for the next two years, which will hurt banks’ lending margins. Businesses and consumers are stressed, meaning outstanding loans look riskier. The current stand-off among fiscal policy makers, if it continues, will only worsen the outlook. See my most recent blog post here.
With the Fed having added $3.0 trillion of liabilities to bank balance sheets, lending has exploded. The impact on equity prices are plain to see. However, values in every segment have appreciated as well. High yield bonds and municipal bonds are two recent examples. In addition, beyond the provision of reserves, the very large collection of programs the Fed has launched over the past six months have supported nearly every market segment. Unfortunately, not all borrowers are creditworthy. Many will not make it – the zombies. Banks and other lenders will eventually feel the pain.
As a result, the pressures on financial services sector firms to transform are strong now, but will be immense in the period ahead. Banking services with even greater technology content can be expected. Fintechs focusing on innovative, new services – and staying clear of new forms of lending – will increase the pressure on the traditional players.
Retail banking services can be expected to make much greater use of artificial intelligence and machine learning to anticipate consumer borrowing needs, bill paying requirements, and investment opportunities.
The widespread and increasing use of mobile banking – growing out of the pandemic – means that consumers are now much better positioned to benefit from technology’s guidance, improving income and wealth opportunities. While branch banking and branch bank employees have generally increased over several decades, despite increased automation, the curve is finally bending and the branch bank physical footprint is beginning to shrink.
The payments opportunity is very likely the largest opportunity, accounting for 40% of bank income. The Federal Reserve has just announced the details surrounding its FedNow program. See Lael Brainard’s remarks here. The Fed is following a similar effort by the Bank of England. Other central banks will follow as well. FedNow’s focus on retail payments is on the smaller and less competitive side of the market. The true battle will be for enterprise payments. The large banks will fight to the death for the enterprise payment opportunity.
In a related development, the Boston Fed is collaborating with researchers at MIT in a multiyear effort to build and test a hypothetical central bank digital currency to understand the potential and risks that new technologies present to payments. See last week’s remarks from Lael Brainard here.
While the support provided by the Fed has cushioned the blow in the current crisis, the adjustment over several years will be painful. However, if technology and innovation is allowed to flourish, which has been the subject of its own debate, the economic benefits could be substantial.
Martin Fleming's Blog 