US Banks Facing Dismal Profit Outlook and Potential New Regulations

As we move into the second quarter of 2023, US banks find themselves on uncertain terrain, facing a challenging profit outlook and the possibility of new regulations. The aftermath of the financial crisis that unfolded this past spring has left the banking industry grappling with the implications of a changing landscape.

On July 14, the earnings season for the second quarter is set to kick off with reports from three banking giants: JPMorgan Chase, Citigroup, and Wells Fargo. Following closely behind, Bank of America and Goldman Sachs will release their reports in the early part of next week. These reports from the industry frontrunners not only offer a glimpse into their own performance but also provide valuable insights into the behavior of American consumers, given the banks' extensive credit card and lending practices tied to home and car loans.

However, the focus is not solely on these industry titans. Attention will then shift towards other regional banks, such as Cleveland-based KeyCorp, Dallas-based Comerica, Los Angeles-based PacWest BanCorp, and Alabama's Regions Financial. These mid-sized banks have recently experienced a wave of declines on Wall Street, raising concerns that the crisis that affected Silicon Valley Bank, First Republic, and Signature Bank may also impact them.

When it comes to earnings, the largest banks are expected to see a change from the previous year. Analysts anticipate a downturn, primarily driven by a sluggish mergers and acquisitions market, which dampens investment banking revenue. While mid-cap banks face similar challenges, their outlook is generally worse. They are also contending with withholding deposits due to shifting US monetary policy.

The US Federal Reserve (Fed) has raised interest rates consistently since the beginning of 2022, responding to inflationary pressures that have disturbed the low-interest-rate environment that prevailed for an extended period. Stuart Plesser, senior director of S&P Global Ratings, suggests that banks are now obligated to pay for deposits to retain them. In May 2023, S&P changed the credit rating outlook to "negative" for nine regional banks, although they maintained their investment-grade status. While analysts predict some deposit withdrawals in the upcoming period, they do not foresee a dramatic drop comparable to April 2023, when commercial bank First Republic Bank experienced a substantial decline of over 40% in deposits, subsequently leading to a government auction a week later.

Additionally, mid-sized banks face the burden of significant new regulations that could potentially limit lending activities. On July 10, Michael Barr, the Fed's vice president of oversight, announced a series of measures aimed at tightening regulatory control and banking supervision. These regulations include higher capital requirements for banks with assets of at least $100 billion, as opposed to the current standard threshold for banks with assets of $700 billion or more. This change will undoubtedly impact many banks in the region, as they will need to allocate higher payments to retain deposits.

The challenges faced by US banks are multifaceted. They are grappling with a potentially dismal profit outlook, grappling with new regulations, and contending with a shifting economic landscape. The road ahead is uncertain, and strategic decision-making will play a critical role in navigating these turbulent times.