Despite predictions of slowing growth over the next year, Kroll Bond Rating Agency (KBRA) is predicting that the banking industry is well-positioned to remain stable in its “2020 U.S. Banking Outlook: Resilient Despite Headwinds.”
The industry’s record high profitability levels have come with a healthy dose of durability, according to the analytics firm. That combined with relatively low risky asset concentrations compared with previous growth periods led KBRA to conclude that “the U.S. banking industry is well positioned to withstand an economic downturn.”
In its report, KBRA credits regulatory actions, policymaker initiatives and effective market discipline as catalysts for positive changes in banking fundamentals since the financial crisis. The firm supported its conclusions by pointing to “materially higher” capital levels, improved liquidity management, lower loan risk and enhanced profitability stemming from corporate tax reform across the industry.
The firm addressed the challenges facing the industry in the report in detail, as well as to provide a balanced view of what lies ahead for the banking sector. For instance, the report notes that “the longer the expansion persists, there is an increased propensity for the system to build vulnerable excesses” and that “activity originating from nonbank funding (shadow banking) has aggressively stepped into riskier parts of the loan markets on both the consumer and commercial sides of the borrower spectrum.”
Expressing confidence in its conclusions, KBRA states its outlook for the banking sector could deteriorate in the “unlikely event” that the following negative trends become significantly evident:
- “Aggressive acquisition strategies, including large out-of-market acquisitions or extensive ventures into business segments without commensurate management experience;
- Riskier lending activities or a substantial loosening of credit quality standards; or
- A marked deterioration in funding profile or liquidity management.”
Throughout the report, KBRA analyzed balance sheet growth potential, operating leverage and competitive dynamics present in the marketplace. The firm also touched on how the banking sector stacks up against its non-bank competition.
“Intense competition among banks and the continued growth of non-bank lenders have made it more difficult to achieve loan growth targets while maintaining risk-based pricing and underwriting standards,” the report states. “That said, KBRA notes that all segments continue to run in excess of U.S. GDP growth. … [T]he vast majority of traditional banks do not appear to be taking undue risk to achieve additional revenue growth, with more aggressive behavior emanating from various non-bank financial institutions. Unlike before the financial crisis, when many commercial banks stretched their credit boxes and otherwise engaged in all manner of alternate risk-taking activities in the pursuit of revenue growth, much of the excesses appear to be happening away from banks, namely loosening underwriting standards (i.e., covenant-lite), nontraditional credit structuring (i.e., extended I/O structures), and irrational pricing.”
Regarding possible industry disruption from a technology perspective, the firm asserts an opt-cited argument as to why banks should not be overly concerned about challenges from fintechs – the banking industry is too highly regulated for most non-bank entities to gain traction.
KBRA also asserts that the specialized nature of certain lending activities, particularly in the commercial space, offers some insulation from disruption and that banks constantly are improving their internal technology to compete with would-be disruptors.