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Why the banking sector will be resilient in 2023

The boost to net interest income may prompt institutions to look beyond immediate pressures to wider changes in the world and opportunities ahead.

Jan 9, 2023 / Consumer Banking

Twelve months ago, I had hoped for a less volatile 2022.

Lingering effects of COVID-19 in some markets, wider geopolitical tensions, inflation and the prospect of recession in many major markets kept banking leaders busy. Banks had to implement sanctions, reassess credit and market risk exposures, think about their operations and people strategy, strengthen cyber resilience and, of course, adapt to the everchanging regulatory environment.

One of my major reflections on the upheaval of the past year is just how resilient the sector is. As the IMF’s recent Global Financial Stability Report highlighted, “High levels of capital and ample liquidity buffers have bolstered the resilience of the global banking sector.” But it isn’t just capital and liquidity strength – it is the ability to manage radical change in response to unexpected external pressures.

The resilience of the formal banking sector is in some ways a contrast to the non-bank financial (especially crypto) sector, which is now starting to see greater regulatory scrutiny. Meanwhile, the gap in valuations between fintechs and traditional banks has narrowed significantly. In an upward rate environment, posting great customer growth numbers will no longer be a substitute for actual profitability.

As I look to the coming 12 months, I suspect that we are perhaps entering a period of “stabilized volatility” from a geopolitical and macroeconomic perspective. The key for me is determining which disruptions will be temporary and which will be permanent.

Here are my four bets for why the banking sector will remain resilient in in 2023.

Banks will see the upside of the monetary tightening-recession paradox: Average returns on equity for major global banks could rise between 0.5 and 1 percentage point, with the beta effect of rates on net interest income the key driver. The return of deposit margin will be particularly welcome for many banks. While monetary tightening into a recession raises concerns about loan losses, regulatory action following the global financial crisis has limited exposure to riskier segments. Further, generally strong consumer balance sheets should limit asset-quality deterioration. Uncertainty is likely to have a negative impact on equity markets and mergers and acquisitions. As the macro environment stabilizes in the second half of the year, I expect to a rebound in M&A and issuance.

Banks will focus on expanding their customer base and services: Rate rises will boost revenue for most lending businesses but beyond this, investors will be looking for banks to create alpha. I see two areas as a focus for income growth. The first is ancillary services they can offer clients, particularly small and mid-sized businesses. This includes legal, advisory and risk management capabilities, or helping clients understand and mitigate their carbon impact. The second area of opportunity will be serving the previously unbanked or underbanked. A decade ago, 40% of adults in the developing world had a bank account. Last year more than 70% did.

Technology investment will continue to grow: I remain skeptical of the argument that banks are really technology companies (those that genuinely are seem to be going through a tough time now), but they are certainly technology-powered. They will have to keep investing heavily in technology to keep pace with innovation.

Reports of the death of ESG are greatly exaggerated: More than 120 major banks are signed up to the UN’s Net-Zero Banking Alliance, representing around 40% of global assets. An EY review of 100 of the world’s largest banks shows that nearly 90% have clearly defined their long-term net-zero emission targets, although there is still work to be done by a significant minority providing metrics on their progress. I expect further strides forward in the coming year, but also greater evidence of sustainability targets being embedded in the KPIs of banking leaders and increased efforts to build confidence in sustainability reporting.

There was no time for a breather in the past 12 months, and I fear the same is also true for the next 12. But the benefit of the boost to banks interest income is that it may afford them some time to look beyond the immediate pressures of geopolitics and macroeconomics to the wider changes in the world and the opportunities ahead.

Transformation is always hard, but the lesson of the last few years is that the banking sector is exceptionally good at it, thanks to its resiliency.

Jan Bellens is global banking and capital markets sector leader at EY