Large US banks face funding and liquidity challenges in 2024: Moody’s

By Puja Sharma

“Moody’s outlook for global banks in 2024 is negative as central banks’ tighter monetary policies have resulted in lower GDP growth. Reduced liquidity and repayment capacity will squeeze loan quality, leading to greater asset risks. Profitability will likely subside on higher funding costs, lower loan growth and reserve buildups. Funding and liquidity will pose challenges, but capitalization will remain stable, benefiting from organic capital generation and moderate loan growth and as some of the largest US banks build up capital,” said Felipe Carvallo, Vice President – Senior Credit Officer at Moody’s Investors Service.

Key Drivers of the Outlook:

• The operating environment will deteriorate under tight monetary policies: Major central banks will start to cut rates, but money will remain tight, resulting in lower GDP growth in 2024. Inflation is slowing, but geopolitical and climate risks remain. China’s economic growth is set to slow on muted private spending, weak exports and an ongoing property market correction.
• Loan quality will be squeezed by low liquidity and tighter repayment capacity: Past rate hikes will lead to greater asset risk and reserve buildups. Rising unemployment in advanced economies will weaken loan performance. Commercial real estate exposure in the US and Europe is a growing risk; in Asia-Pacific, specific property markets face stress. Chinese banks face risks from slower economic growth and second-order impact from a prolonged property downturn.
• Profitability will fall on higher funding costs, lower loan growth and loan-loss provisioning needs: Profitability gains from the last two years will likely start to subside, but remain sound. Higher funding costs will shrink net interest margins, while loan production will continue to weaken as rate hikes limit demand and credit standards tighten. Provisioning expenses will follow increases in asset risks, while operating expenses contend with rising tech-related investments and new regulatory costs.
• Funding and liquidity will be more challenging because of monetary policy tightening: Deposit growth will decelerate as deposits move to more expensive accounts or exit banking systems, while market funding increases. Lower loan growth will limit funding strains. Foreign currency shortages will strain liquidity in some frontier markets.
• Capital will remain broadly stable: Banks in Europe will maintain ample buffers above regulatory minimums. In the US, some of the largest banks will build capital because of regulatory changes. In Asia-Pacific, organic capital generation and prudent dividends will allow capital stability.

Trends in Western Europe

• Banks’ lending to households and the corporate sector will continue to decline, reflecting tighter underwriting and muted loan demand.Tightening underwriting standards, which we are seeing among US banks and European banks, in response to rising asset risks can lead to credit contraction, which in turn reduces growth.
• Loan performance will weaken, but only moderately. In Europe, falling property values will result in more problem loans, but banks are well capitalized and the credit quality of their CRE loan books is strong. Banks in Sweden are the most exposed because of very high CRE concentrations and a deeper downturn in the local property market.
• Growing and less-regulated private credit markets may take away lending opportunities from the banking system, but they also tend to finance weaker and more highly leveraged borrowers who are susceptible to higher interest rates. As banks provide funding to private lenders, any deterioration of credit quality in the private credit system may be reflected in increased loan-loss provisions and spill over into regulated banks as well.
• After significant improvement, profitability will stabilize. Net Interest Margins in Europe and Asia-Pacific will continue to benefit from loan repricings, with a relatively more gradual pass through to funding costs. Banks with extensive capital market franchises will benefit from diversification
• Capital buffers will remain ample. European banks have among the highest risk-weighted capitalization ratios and will maintain ample buffers above regulatory minimums.

Trends in Africa

• Operating conditions will remain difficult, but banks are accustomed to navigating turbulence.
• Egypt, Kenya and Tunisia have large refinancing needs, including in foreign currency, and are among the most exposed to debt rollover risk or higher interest rates further weakening debt affordability. Ghana  completed its local currency debt restructuring in 2023, but its foreign-currency debt restructuring remains pending. Sovereign debt exposure links banks’ creditworthiness with that of the sovereign, and is highest in Egypt, Kenya, Ghana, Tunisia and the West African Economic and Monetary Union (WAEMU).
• African banks will likely remain well capitalized and continue to gradually roll out stricter Basel capital regulations, although progress will vary widely.
• Profitability will improve on higher rates, but forbearance will mask weaker underlying earnings.
• Local-currency funding will be stable. African banks will remain primarily deposit funded in local currency. However, tight global conditions will increase costs for those raising funding in eurobond debt capital markets.
• Foreign-currency shortages will pose risks to banks’ liquidity.

Trends in Gulf Cooperation Council (GCC), stable

• GCC banks have historically maintained strong capitalization and we expect the same for the outlook period.
• Liquidity buffers will stay ample. Profitability will remain strong, supported by low provisioning requirements and high margins.
• GCC banks lend primarily to the non-oil sectors and have small direct exposure to carbon transition risks. Nevertheless, the health of GCC economies tracks changes in oil prices and government spending remains the main profit driver for non-oil businesses