Regulatory change likely on the way following U.S. bank turmoil, Fitch says

Funding challenges will continue to weigh on the results of U.S. banks this year, but deposit declines appear to have stabilized for the moment, according to a new report from Fitch Ratings.

The rating agency said it continues to forecast weaker financial performance from the U.S. banking sector in the wake of several prominent bank failures and the tighter financial conditions that helped lead to those events.

The higher interest rate environment and gloomier economic outlook have driven a shift in banks’ funding conditions, including an outflow of deposits for some banks and a shift in the deposit mix, resulting in costlier wholesale funding and tougher lending standards, which will impact credit growth and loan losses.

The costlier funding environment will increasingly weigh on banks’ net interest margins and profitability this year, the report said.

Fitch said it expects credit conditions to worsen in the second half of this year and into 2024.

“Segments likely to garner more scrutiny in coming months are middle-market and small business loans where refinancing may be more challenging in a tighter credit backdrop and higher growth areas such as credit cards,” it said.

Segments within commercial real estate are also concerning, it added, “including the underlying collateral that has been meaningfully impacted by higher interest rates, offices that have faced structural shifts in demand, and areas with sizeable near-term refinancing risk.”

Fitch has taken several negative rating actions on the banks most affected by the turmoil. “Idiosyncratic issues” could continue to emerge, it said, as the operating environment evolves and potential regulatory changes develop.

That said, the report noted that most banks are facing these tougher economic and financial conditions with strong profitability, asset quality, capital and liquidity positions, which should enable them to ride out the storm.

Additionally, Fitch reported that deposit outflows have stabilized since late March and are down about 3% through the first four months of the year: down 4.4% for smaller banks, compared with 2.3% for large banks.

While money market funds remain a competitive threat to bank deposits in a higher-rate environment, Fitch said “the flow of deposits since the end of March appears to have been largely driven by seasonal tax payments rather than a shift into money market funds.”

Longer term, the banking sector will likely face tighter regulation, the report said.

“The aftermath of the recent bank failures is likely to include a significant regulatory policy response,” Fitch said, including possible changes to capital and liquidity requirements. Any major changes would likely be phased in over time, rather than adopted immediately, it said.

“Increased transparency and regulation would generally be viewed favourably from a creditor and ratings perspective. However, impacts to profitability and the potential for unintended consequences will need to be assessed once new regulatory requirements are introduced,” it said. “Nonetheless, we expect regulatory uncertainty to be an overhang for banks over the near term.”

James Langton

James is a senior reporter for Advisor.ca and its sister publication, Investment Executive. He has been reporting on regulation, securities law, industry news and more since 1994.