Interview, Fireside Chat
Focus on financials: Why banks and asset managers are constructive about the economy in 2024
- Most banks now expect a "soft landing" for the economy next year, with a base case scenario of a technical recession lasting one or two quarters.
- Prospects for interest rates rising another 100 to 200 basis points to combat inflation have been significantly reduced, though a "higher for longer" rate environment is projected.
- Unemployment and corporate default rates are anticipated to remain "really, really low" despite the expected slowdown in economic growth and consumer spending.
- Loan growth is expected to stay near zero or negative in the near term due to tighter underwriting standards, increased capital requirements, and competition from non-bank lenders.
- Underwriting standards are projected to continue tightening over the next two to three years as banks anticipate rates peaking and eventually falling.
- Commercial banks are expected to lose loan origination market share to non-banks as the private credit market grows at an annual rate of 20% to 25% over the next five years.
- Institutional allocations to private credit are expected to rise from a current average of 3% to as high as 10% as asset managers shift capital from alternatives toward fixed income.
- While private credit is expected to experience losses during a credit cycle, systemic risk remains lower than in the banking sector due to longer funding durations and lower leverage.
- Large banks expect to lose between 8 and 12 cents on the dollar for their entire office loan portfolio, with contagion risk contained within commercial real estate while multifamily markets remain distinct.
- Basel III endgame regulations may require the largest U.S. banks to hold 15% to 30% more capital, potentially resulting in average holdings of two and a half times more capital than in 2007.
- Increased capital requirements are expected to raise borrowing costs for end users, including mortgages, green energy, small businesses, and credit card loans.
- Banks are projected to face a reduced ability to provide liquidity and leverage in the Treasury market, which could increase funding costs for the U.S. government and amplify market corrections.
- Deposit flows are expected to remain "remarkably stable" over the next few months due to competitive savings rates and retained operational cash, though banks will hold more liquidity and shorter-duration securities following 2023 deposit runs.
- Smaller banks are expected to pursue M&A activity to achieve the scale necessary for competitiveness under exponentially increasing capital and liquidity requirements.
- Larger banks are expected to prioritize competitive technology and convenience to retain consumers, as digital experience becomes more critical than price.
- Capital currently in money market funds is expected to move into other fixed income forms, requiring asset managers to extend duration and take on credit risk.
- Electronic market makers and high-frequency firms may not reliably act as backstops during extreme volatility, making liquidity provision in financial markets more vulnerable.
- Regional bank failures will continue to influence risk management strategies, forcing banks to diversify deposit bases to avoid over-reliance on specific sectors or geographies.
- Private credit providers are expected to fill the market gap created by banks facing regulatory scrutiny and shifting liquidity requirements by building out origination capabilities.