A New Year Brings New Considerations for Banking

February 2022

BY

Mark HoustonNational Financial Institutions & Specialty Finance Industry Leader

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In addition to interest rates, several banking profit streams on the consumer side are beginning to slow, regulatory requirements are shifting, and longstanding policies, like overdraft and insufficient funds fees, are facing increased scrutiny.

Fintech companies continue their strong growth, which will continue to take market share from brick-and-mortar financial institutions. This year, banks can plan to manage their need to address existing trends while preparing for emerging growth opportunities.

Here are 7 banking predictions for 2022
 

Prediction #1

Digital options are becoming the norm

Whether customers were restricted by an official lockdown or personal efforts to curb the spread of COVID-19, the pandemic diminished customers’ comfort with physical banks. As a result, the pandemic accelerated the rise of online banking, even converting historically hesitant older generations to digital transactions. A recent survey found that 100% of Americans aged 66 to 75 have completed an online financial interaction in the last three to six months. Reliance on digital banking is expected to continue even as COVID-19 fears subside. The same survey found that 26% of all respondents plan to avoid in-person banking altogether, regardless of the bank’s safety measures.

Banks are likely to encourage digital spending as the industry continues to see increased usage of online financial wellness reporting, fraud detection services and in-app agent consultations, among other offerings. At the same time, new apps are entering the market, ushered by fintech banking platforms that are disrupting the industry with tech-focused solutions.

Fintech companies will likely continue to gain market share from traditional banks as new banking clients gravitate towards their platforms’ ease of use. Customers are becoming more familiar with fintech as the sector continues to revolutionize bill payment, e-commerce and other services. Banks can take this opportunity to assess the security and convenience of their digital offerings and plan for strategic ways to secure their place in customers’ daily lives.
 

Prediction #2

Regulatory requirements are shifting

As traditional banks embrace new technology and fintech becomes more firmly established in the industry, regulation is increasing. Emerging financial regulations aim to combat any criminal activity that technological advances in banking might allow.

Under upcoming regulations, banks can anticipate more responsibility to prevent fraud.

As banks rely more heavily on third-party software and fintech partners, they should bolster measures to safeguard customer data from cyberattacks, which frequently target financial services. A pandemic-induced increase in cyberattacks has intensified regulatory scrutiny and led to the introduction of new requirements — such as the rule on reporting cyber incidents passed in November by the Federal Reserve, Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC). Banks may also focus on how they handle data collection and post-incident communication in the coming months.

The regulatory environment will continue shifting to accommodate the increased number of companies that operate in the banking industry, as well as the innovative technology the industry is adopting. As a result, banks can benefit from investing in resources to meet evolving regulatory requirements in 2022. One solution that’s on the rise is regulatory technology, or regtech, which can automate the analysis of data and help reduce operational costs.
 

Prediction #3

Banking is embracing ESG values

In response to criticism that punitive fees disproportionately impact people of color and low-income consumers, smaller banks have cut insufficient funds fees and overdraft fees in recent years. In December 2021, Capital One became the first large institution to follow suit. The next month, Bank of America announced that it would eliminate insufficient funds fees and reduce overdraft fees from $35 to $10 starting in May 2022. Wells Fargo soon took similar action on such fees.

Banking’s move away from punitive fees is part of the industry’s larger shift towards environmental, social and governance (ESG) values. The pandemic underscored many social inequities, prompting lawmakers, shareholders and members of the public to hold industries accountable for actions that may have contributed to those inequities. Banks also face pressure to ensure the companies they conduct business with are similarly exercising ESG due diligence.

ESG is fast becoming an integral component of a bank’s sustainability, and it’s a priority for investors as well. Sustainable funds drew $51.1 billion in new money during 2020, more than a tenfold increase from 2015’s total, according to Morningstar. As environmental and social responsibility becomes intertwined with economic stability, it can benefit banks that prioritize ESG.
 

Prediction #4

Bank M&A activity remains strong

2021 saw new records for overall deal activity, and M&A involving U.S. banks surpassed $77 billion in total value, a 15-year high and nearly more than 2019 and 2020 combined. Synergies focused on revenue growth were the main drivers of increased M&A activity. Some banks merged with fintech companies to streamline processes and expand service offerings. As pandemic-era work-from-home initiatives inspired many to move to states in the American South and West, banks in popular locations like Florida and Texas have benefited from an influx of new customers. The growth of their balance sheets has made these banks attractive acquisition targets for banks where customer or economic growth is stagnant.

Bank M&A activity is expected to continue at strong levels in 2022. Banks looking to make an acquisition can consider whether the target is financially compatible with their value creation goals and whether the acquisition will be a good fit. Though banking has fared better than most industries during the current labor shortage, workplace culture is a key factor in attracting and retaining talent. Institutions looking to be acquired can increase their appeal by demonstrating a commitment to ESG values and digital transformation — two factors indicative of sustainability.
 

Prediction #5

Pandemic profits are slowing but interest rates are on the rise

Banking was one of a few industries to profit during the pandemic, a trend attributed to government stimulus and fewer loan defaults than originally anticipated. The economy also recovered more quickly than expected.

Though banking ended 2021 on a high note, fourth-quarter 2021 profits fell at major banks.

Economic recovery was not only quick, it was dramatic. Federal aid and the COVID-19 vaccine rollout converged to create significant demand for consumer goods. The labor shortage and supply chain struggles made it difficult to meet that demand. In December 2021, consumer prices soared 7% higher than they were 12 months earlier, the largest year-over-year inflation since June 1982.

The Federal Reserve has indicated that it will soon raise interest rates to curb inflation. It might be years before earnings reach 2021 levels again, but 2022 is still projected to be a good year for the banking industry.

Strong commercial loan activity and consumer mortgages drove significant profits in 2021. Commercial loan activity is expected to increase, particularly in 1H22 while interest rates remain low. Consumer mortgages are also indicating a strong start to 2022, possibly driven by borrowers trying to lock in home loans at lower interest rates.

Loan defaults are expected to continue to be low in 2022 as borrowers will be able to use the supply chain impact rationale to defend their earnings. However, banks will be less tolerant of underperforming companies outside of those with reasons related to COVID-19 and supply chain disruption.

Financial institutions are expected to be more stringent in the enforcement of credit agreements.
 

Prediction #6

The future of banking

Our 2022 predictions are a window into banking’s future. Further down the line, the industry can expect continued pressure to digitize, including through widespread consumer adoption of apps. Though M&A activity is projected to remain strong, supply chain disruption continues to loom.

Digital
Brick-and-mortar banks are on a decline that is expected to continue. Advances in artificial intelligence (AI), cardless payment options and personalization promise to help banks expand their customer base. However, technological advancements in digital banking may lead to the elimination of some legacy industry jobs.
 
Apps
Mobile banking apps are already becoming a staple of mainstream banking institutions, and the quality of the app experience matters greatly. A recent survey found that 65% of millennials are willing to switch banks in search of a better mobile banking experience. The standard for mobile banking apps will rise considerably to include cardless ATM features, which leverage smartphone security to better protect customers’ information. Along with heightened expectations for security will come heightened expectations for customer service.

M&A
Though rising interest rates could slow consolidation in the banking industry, baseline M&A activity in this sector is historically strong. M&A will continue to hinge on banks’ desires to adapt to evolving consumer demands, whether that be through expanding digital services or upholding ESG values. There’s also a strong need for banks to sustain financial health and consolidate resources while profits in the market are low. Consolidation with a more advanced bank or fintech is a relatively quick and cost-effective avenue to progress.
 

Prediction #7

Ongoing supply chain disruption

Supply chain disruption will exist to varying degrees regardless of COVID-19. Two years of contending with pandemic-era dysfunction has caused banks to reevaluate their connection to the global supply chain and develop the following mitigation strategies:

Understanding of risks
From labor shortages to increases in cybercrime, banks are faced with a variety of shifting risks. To understand the risk such threats pose, banks can benefit from greater clarity about their assets, operations and data. An understanding of internal mechanisms will help mute the impact of external threats.
 
Scenario planning
From predictions of economic collapse to unprecedented profits, COVID-19 helped banking come to expect uncertainty. The future cannot be predicted, but possible scenarios can be envisioned. Banks can engage in scenario planning, which involves imagining several realistic situations, estimating their financial and operational tolls and brainstorming ways to proactively blunt their impact.

Adjusting trading securities based on interest rate risk
Though the Fed is taking steps to quell rising inflation, it can help to have interest rate risk top of mind. Banks may benefit from exploring trading securities adjustment options, such as forward rate agreements, futures, swaps, options (or a combination of the two, known as “swaptions”), embedded options, caps, floors and collars.
 
Identifying vulnerabilities
As banking embraces digital solutions, the industry faces greater exposure to cyberattacks targeting the supply chain. Securing the supply chain requires banks to have a firm grasp of their vulnerabilities, whether that is a third-party software provider or a remote employee.

Rethinking go-to-market strategy
Banks can consider workers’ and consumers’ diminishing comfort with in-person interactions when planning the launch of a new product and consider a digital approach to meet evolving demands.
 

A familiar approach carries banking into the future

The future of banking is expected to look much like its recent past: a shifting landscape that requires an innovative mindset. Banks that embrace digitalization, comply with shifting regulatory requirements, take a creative approach to risk mitigation and stay open to M&A activity can go confidently into the future.