In some economic circles, there is an overall sense of stability and comfort in the banking sector at the beginning of 2024.  However, as we examine the 2023 financial results for banks, we are struck by the picture that appears.   

Since the sub-prime crisis of 2008-2009, when many banks experienced near death situations, most financial institutions have focused on improving their capital structures and on meeting increasingly demanding regulatory controls in the hope that major hiccups in the economy could be more easily absorbed by the financial institutions.  The phenomenon has given rise to a large risk and compliance cottage industry that reaches levels never seen before in most banks. 

Furthermore, the banks went through the COVID crisis with massive support from the government.  A look at the banks’ current results shows that an impairment needs to be repaid by banks that have benefitted from government support, for the next eight quarters starting in January 2024.  In many cases the amount is not unsignificant.  Banks that were helped by the government during the COVID crisis included premier companies such as Goldman Sachs, Morgan Stanley, or JPMorganChase, not to mention many other institutions in the country.  FDIC is now coming back to ask its members to pay, in a form of group participation, for the costs of the banks that have failed in 2023.  That means that FDIC was underinsured for a few small banks (SVB and Signature) failing… 

Let us do some minimum fiction: what would be the price to repay if a major institution were to fail?  Likely improbable, but never impossible.  We might not be able to afford it next time. 

Now does anyone really believe that if a mid-size to large bank was facing difficulties, much like Credit Suisse not so long ago in an adjacent market, regulatory and capital reserves would suffice?  All the stress testing tells us it might work but we don’t really know, do we?  In fact, everyone hopes that it would hold.  And to make sure that the proof is solid, every bank continues to add resources in risk and compliance, and the regulators continue to add requirements to make sure the system will stay afloat.  It is a hope that will only reveal itself when a real situation arises. 

We know now that interest rates are not being reduced by the FED in January.   Will they be in March?  Who knows, but likely not.  The earliest possible date for a rate reduction seems to be May.  Even if the US political agenda is taken into account it is likely that the economic pull due to lower rates will not happen too soon.  But JPMC in its fine print for 2024 projections indicates that it plans for 6 rate reductions in 2024!  Really?  That seems overly optimistic.  And what if we experience only 2 rate reductions?  Here goes a major assumption for a rebound of the economy in 2024. 

So, we can expect that interest rates will continue to put pressure on consumers and businesses alike.  The banking results published for FY2023 tend to show that in many areas credit worthiness is degrading, only a little, but, nonetheless, visibly.  In order to make sure we would not panic, Bank of America even included historical analyses going back to 2007 showing that it was worse then.  That looks more and more like spinning.  And it looks like a tsunami, a small wave from afar that could become very big as it hits land. 

A lot of hopes seem to be placed in the use of AI, including gen AI.  However, when observing existing projects, we are still missing some key components such as a lack of ROI, half-completed automation projects left stranded, accompanied by a fear of replacement by loyal employees, and a hope that an AI monetization will make so many worries disappear.  Managing the transition phase seems something more complicated than simply managing a project as it deals with the heart and soul of employees.  And who will pay for all the new  technology: consumers, companies? 

On the war front we are beginning to accept that the Middle Eastern conflict might last longer than expected.  The closure of the Suez Canal for most shippers will have an impact on supply chains and on the costs of shipping.  It will fuel inflation.  And that is in addition to the resource consuming Ukrainian conflict, now entering its third year. 

But the biggest concern remains the size of corporate real estate loans due to be refinanced in the coming 18 months, between $1.5 and 2.5 trillion.  To reduce their exposure, some banks are segregating the risks between investor, owner occupied, operator, etc. It is likely a healthy and pragmatic approach to a balloon that will take some time to deflate.  And will it be just deflating or exploding?  That is a question that hopefully will be treated differently than China Evergrande was in Hong Kong! 

If we focus on what banks should be doing, they should make sure they remain as lean as possible.  The cost cutting efforts mentioned by many (e.g., Citi, Barclays, Morgan Stanley), the relatively flat performance bonuses, the continued attention to bad debt reserves are all good conservatory measures.  We also continue to believe that the current financial pressures on banks will facilitate banking consolidation in the United States; we begin to experience some signs.  And more importantly the new state of affairs will require a profound change in the DNA of bankers to embrace digital opportunities and changes at deep levels.  Finally, we should remain careful about the outlook for banks in 2024.