The Big Picture 2022 Banking Industry Outlook

Introduction

The U.S. government’s efforts to flood the markets with cash in the aftermath of the COVID-19 pandemic has proved a double-edged sword for banks by propping up borrowers but leaving institutions flooded with excess cash. At the same time, the pandemic pushed many banking customers to conduct business through digital channels, including those offered by well-funded fintechs. Amid a tough earnings environment and changing competitive landscape, some banks are working to modernize their offerings, while others are pursuing mergers in the face of daunting challenges.

The Take

Government aid and forbearance provided by U.S. banks has kept many borrowers afloat, but the relief efforts have left bank balance sheets sodden with excess liquidity. That excess cash will remain on their balance sheets for the foreseeable future, leaving bank margins below pre-pandemic levels for the next few years. Many banks could see little to no earnings growth over the next few years, particularly smaller institutions that still have not adopted a new forward-looking reserve methodology that could require higher reserves. Institutions looking to avoid that scenario likely need to find a way to become more efficient, expand their product offerings, or add exposure to assets outside their footprint and normal origination channels. Such changes introduce new risks and could prove daunting enough to encourage many institutions to pursue mergers.

Bank M&A activity should continue to heat up as institutions seek scale to combat the challenging earnings environment. Easing credit concerns have brought buyers back into the fray, while potential sellers see transactions as a way to mitigate revenue headwinds from excess liquidity and low interest rates by cutting costs, including through consolidating branches. These physical distribution channels have fallen in favor relative to digital channels during the pandemic. M&A allows institutions to right-size their costly branch networks while making necessary technology investments that enable more effective competition with fintechs. Fintechs continue to attract huge sums of capital, allowing them to compete aggressively for new business. The path toward convergence for banks and challengers should continue.