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Economy: The Banking Outlook

 

Because long- and short-term interest rates are at historically low levels and the yield curve is very flat, banks will be pushed to purchase a greater proportion of assets with longer maturities.

This means many banks will take on credit risks that could come back to haunt their balance sheets should long-term interest rates rise substantially. Long-term rates are expected to rise slightly in 2014, but the Federal Reserve is not expected to raise short-term policy interest rates until late in 2014.

Net interest margins are poised to widen slightly in 2014, which will provide some support for banks’ profits and will be vital to generating profits.

Deposit growth will continue due to high levels of anxiety regarding economic growth and the federal government’s fiscal and monetary policies. Deposits will grow faster at online banks, small community banks and credit unions than at larger banks or at savings and loans. Competition for deposits will intensify, benefitting savers while reducing overall margins earned on deposits.

Due to substantially lower cost structures and more use of mobile money, online banking’s advantage over traditional banking will widen. The increasing proportion of mobile banking, more intensive financial regulations and cost pressures will prompt reductions in the number of bank branches. 

In 2013-14, financial institutions will begin to benefit from the new upcycle for residential real estate, declining mortgage default rates, home price appreciation, higher spending for consumer durable goods, high levels of corporate profits and slightly more opportunities to boost earnings derived from mergers and acquisitions and IPOs.

Gradual improvement in the housing market and slightly more new mortgage origination will have the greatest benefits for community banks. New loans in 2013-14 will generally prove to be very good ones. 

Georgia’s financial institutions will benefit from improving demographic trends, including population growth and household formation. The inflow of new residents – including retiring baby boomers – increases the demand for banking services, props up asset prices and encourages new business formation.

When the Federal Reserve begins to raise short-term policy interest rates, the rates financial institutions pay depositors on CDs will increase even faster. That will reinforce growth of the deposit base while expanding net interest margins.

The long-term prospects for deposit growth are very good, and the household savings rate will rise. Aging baby boomers will gravitate towards safer and more liquid assets.

Businesses need to spend more to improve productivity. As businesses’ confidence in the economic situation slowly improves, the de-mand for loans should rise. Corporate profits are expected to remain at relatively high levels, encouraging companies to dust off some of their plans to expand or otherwise invest.

Banks’ willingness to make new loans – and the quality of their old loans – will continue to be adversely affected by the glut of nonresidential real estate. Banks were exposed to the recession in commercial real estate markets due to increases in commercial real estate loan concentrations, especially construction and development loans. Hence, many financial institutions will remain reluctant to make new commercial loans secured by real estate.

The Dodd-Frank Wall Street Reform and Consumer Protection Act creates new regulators, extends regulations into new areas, provides new consumer/investor protections and gives regulators new abilities to define firms that create systemic risk. This will increase costs for firms providing financial services, primarily at the expense of net margins.

Unfortunately, the new regulations do not focus squarely on the main causes of the financial crisis – financial institutions’ use of pro-cyclical loan-to-value ratios, the moral hazard of deposit insurance and the FDIC, and the pro-cyclical policies of Fannie Mae and Freddie Mac. 

Hence, the new regulations will reduce the efficiency and competitiveness of U.S.-based financial institutions while doing almost nothing to prevent future financial crises.

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