Industry Alert: Robust Outlook For The Banking Sector

Executive summary

• Unprecedented government stimulus and actions by the Federal Reserve to calm the credit markets have kept many borrowers afloat and bolstered credit quality, but banks have traded credit risk for pressure on net interest margins. 
• Fed efforts to flood the markets with liquidity, along with record consumer savings rates driven by government stimulus, supported explosive growth in deposits in 2020. Deposits jumped more than 20% from year-ago levels, leaving banks flush with excess liquidity. 
• Excess liquidity and historically low interest rates wreaked havoc on the banking industry’s net interest margin, pushing the key profitability metric down 55 basis points to 2.77% in 2020. 
• S&P Global Market Intelligence expects margins to remain well below historical levels in the near term, but the outlook for returns is far more favorable now than even a few months ago as credit costs should be significantly lower than previously expected. 
• Returns on equity are expected to rise materially in 2021 as provisions for loan losses decline. As credit costs fall even more, returns on equity should reach double-digit levels in 2022. 
• Few signs of credit deterioration have emerged to date, but asset quality is expected to slide in 2021 as relief efforts, including unprecedented forbearance provided by banks, have waned. Losses will be manageable and, in many cases, bank reserves stand well in excess of projected net charge-offs due to the adoption of a new reserve methodology dubbed the Current Expected Credit Loss model, that went in effect at the beginning of 2020 for institutions holding nearly 90% of the industry’s assets. The provision requires banks to reserve for estimated losses over the life of a loan based on an economic forecast. Since CECL’s initial adoption, the outlook for the economy has improved substantially.

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