Bankers face many challenges heading into next year. The possibility of a recession, rising interest rates and high inflation are all posing headwinds for banks. The rapid emergence of new forms of technology — like “buy now, pay later” financing and cryptocurrencies — and ever-expanding regulations promise to pose longer-term challenges.
BankBeat magazine has compiled the top five trends that have bubbled to the surface throughout 2022 and how they could impact community banks over the next 12 months.
- Interest rates and inflationary environment
Prominent economists and major banks are predicting a brief recession to hit early next year before the Federal Reserve begins to reduce interest rates.
UMB Bank Chief Investment Officer KC Mathews said there is an approximately 75 percent chance of a recession in early 2023 but believes the odds of a significant downturn are much lower. He expects the Federal Reserve’s benchmark funds rate, which was at slightly more than 3 percent as of late October, to reach 4.75 percent early next year before the Fed moves quickly to cut interest rates and avert a prolonged downturn.
“This is not the first nor the last recession,” he said. “We’ll make it through.”
Year-over-year inflation remained high in October at 7.7 percent, but there are already signs that decades-high readings have peaked: Lumber and oil prices have both fallen after seeing sharp increases throughout 2022. Mathews noted that core Personal Consumption Expenditures inflation is expected to drop to 3.4 percent in 2023 before falling even lower, to 2.3 percent in 2024.
The current interest rate environment is part of the Fed’s years-long unsuccessful attempt to hold inflation to its 2 percent target, Mathews said, following a lengthy period of disinflation. That plan was complicated by the pandemic and the following 25 percent growth in the money supply as public stimulus dollars hit consumer bank accounts. To Mathews, the Fed has possibly erred in two ways: By potentially waiting too long to begin raising interest rates and then by raising them too quickly.
Both Mathews and UMB Executive Vice President Steve Kitts advised banks to keep sufficient liquidity on hand for next year and be cautious with the understanding that deposit growth is unlikely in the near future. Community banks are already tightening their credit portfolios out of concern over the impact inflation will have on credit card debt, Kitts noted. “There’s a high probability of a recession, and I think banks are starting to think that way and they’re starting to position themselves that way,” he added.
The UMB analysis aligns with Q4 2022 economic analysis by J.P. Morgan, which found that the year-over-year increase in the trade-weighted dollar, along with weakness overseas, is limiting U.S. exports and will lead to weak real GDP growth along with a more than 50/50 chance of recession by the end of 2023. According to J.P. Morgan, the strong demand for labor means a recession will likely be “relatively mild” for workers.
“While the economy is threatened by recession in the year ahead, the extraordinary excess demand in the labor market has prevented a recession thus far,” the Fed stated. “Though this has eased slightly in recent months, there are still nearly two job openings for every unemployed worker.”
- Overdraft fees
Regulators continued to place bank overdraft practices in the hot seat this year. Multiple bills limiting their use were introduced, and many banks changed their programs. However, bankers and customers still view overdraft/NSF fees as providing a key value, and the odds of Congress passing overdraft legislation appear low for 2023.
Earlier this year, a bill sponsored by Rep. Carolyn Maloney (D-N.Y) was introduced that would amend the Truth in Lending Act and prohibit banks from charging customers multiple overdraft fees in a month and more than six in a year, regardless of whether a customer opts in. However, the fate of the legislation is in doubt after Maloney was defeated during a primary election in August.
A bill introduced in 2021 by Sens. Cory Booker (D-N.J.) and Elizabeth Warren (D-Mass.) would ban overdraft fees on debit card transactions and ATM withdrawals, and limit fees for checks and recurring bill payments. The bill has not received a floor hearing.
JMFA Executive Vice President of Compliance Review Cheryl Lawson doesn’t expect Congress to pass any overdraft legislation in 2023, adding that changes in overdraft policies are more likely to occur by presidential action. Lawson noted that no significant changes to overdraft policy have taken place in the Consumer Financial Protection Bureau’s 12-year history. Regardless of whether overdraft reform passes, she said most of the bill’s elements — including the yearly overdraft limit of six — have already been adopted by banks.
Regulators are still expressing an appetite for overhauling current practices. CFPB Director Rohit Chopra is pledging to take a stronger stand against bank overdraft and NSF fees by enhancing supervisory and enforcement scrutiny of financial institutions “that are heavily dependent on overdraft fees.” Acting Comptroller of the Currency Michael Hsu has said that new rules and credible enforcement threats are needed to bring the overdraft reforms his agency seeks. He called on banks to recalibrate their overdraft programs, possibly by requiring customers to opt into overdraft programs and providing a grace period before charging overdraft fees; allowing for negative balances without triggering overdraft fees; and offering balance-related alerts.
Lawson advised banks to not cancel their overdraft programs and instead review potential regulatory issues that otherwise would fall through the cracks. She still sees overdraft protection as a value-add for banks and customers.
Many larger banks are already changing their NSF/overdraft policies. Bank overdraft/NSF fee revenues in the first quarter of 2022 were 20 percent lower than in 2019, according to a recent CFPB blog post. The $38 billion, Green Bay, Wis.-based Associated Bank eliminated NSF fees when an item is returned; overdraft protection transfer fees; and its continuous overdraft fee.
Smaller banks have also made changes. Grand Forks, N.D.-based Alerus eliminated customer NSF fees and increased the amount an account can be overdrawn before incurring overdraft fees to $50 from $5. The $6.5 billion, Iowa City-based MidWestOne Bank became one of the first Midwest-based community financial institutions to reduce its dependence on overdrafts this past spring. MidWestOne administrators are not looking to recoup the approximately $400,000 the bank expects to lose annually by changing its policy, said Senior Vice President Peggy Hudson in a 2022 interview.Instead, administrators are using the changes to build loyalty among their existing customer base, compete with larger banks and credit unions, and reduce the number of overdraft-related customer complaints, she said.
- Regulatory oversight
The regulatory environment for banks grew more uncertain in 2022 as agencies under new leadership signaled their desire to crack down on large mergers and acquisitions. Fears of coming recession exacerbated regulatory concerns.
That uncertainty promises to remain next year as regulators continue to study merger and acquisition policies and experts caution that a recession is likely to begin in early 2023.
The CFPB has taken an aggressive approach to its regulatory authority. In April, the agency announced it will conduct supervisory examinations of nonbank financial companies that pose risks to consumers, including “potentially unfair, deceptive, or abusive acts or practices, or other acts or practices that potentially violate federal consumer financial law.”
Chopra’s CFPB is also taking on what it deems as “junk fees.” In June, the agency announced it was reviewing the credit card industry’s penalties and published an advanced notice of proposed rulemaking requesting information to determine whether regulations need to be changed to address late fees under the Credit Card Accountability Responsibility and Disclosure Act of 2009.
Chopra’s approach has drawn the support of many Democrats while attracting the ire of Republicans. Senate Banking Committee Republicans penned a letter to the director in September criticizing him for what they deem as adopting a “radical and highly-politicized agenda unbounded by statutory limits, and deploying inappropriate and legally dubious tactics to unfairly damage financial institutions’ reputations and customer relationships.”
All this comes as the funding structure of the CFPB remains in limbo after an appeals court ruled in October that the agency created in the wake of the Great Recession is unconstitutionally funded. The Oct. 19 ruling, written by a three-judge panel in the U.S. District Court for the Western District of Texas, invalidated the bureau’s 2017 payday lending rule limiting the collection options for payday lenders. During a recent IntraFi podcast, former American Bankers Association President and CEO Ed Yingling noted the case, if heard by the Supreme Court, is on stronger ground today than three years ago because of the court’s now-conservative majority.
The M&A policies of banks have been placed under scrutiny following changes at the top of the FDIC. Chair Jelena McWilliams resigned early this year after allegations that prominent, Democratic Party board members were attempting to take control of the agency. Her resignation, effective in early February, eased the path for Democrats to gain control of the FDIC agenda.
In 2021, President Joe Biden issued an executive order calling on the attorney general and heads of federal banking regulatory agencies to update merger guidelines and oversight under the Bank Merger Act and Bank Holding Company Act. Under the leadership of Chair-Designee Martin Gruenberg, the FDIC issued an information request in March to gauge potential changes to its merger review process. The Department of Justice and bank regulators continue to evaluate their M&A policies for the first time since 1995.
As regulators signal a desire to make M&As more difficult, more deals are falling through.Driven by economic and regulatory uncertainty, more than one-quarter of the 20 largest U.S. bank M&A deals that have been terminated in the last decade occurred this year. One of those was the proposed deal between Jacksonville-based VyStar Credit Union and Atlanta-based Heritage Southeast Bancorporation, Inc. Both organizations cited delays in regulatory approvals in calling off the purchase-and-assumption agreement. “The termination was approved by both companies’ board of directors after careful consideration of the proposed transaction and the lack of a clear path forward to obtain the regulatory approvals needed for closing,” a Heritage Southeast press release stated.
Nine U.S. bank M&A deals were announced in September, pushing the total announcements in the third quarter to 40, an increase from 35 in the second quarter, as reported by S&P Global Market Intelligence. Though the nine bank deals were less than the 14 announcements in August, the aggregate value of the deals increased to $1.5 billion in September, the second-highest mark since February.
All signs point to increased regulatory scrutiny of cryptocurrencies and stablecoins in 2023. The Financial Stability Oversight Council, which monitors risks to the U.S. financial system, said earlier this year that crypto-assets could threaten the stability of the U.S. financial system if regulators don’t enforce current regulations and aren’t granted more power over the space.
Banks must be cognizant of any customers who use cryptocurrencies and stablecoins from both an underwriting and safety standpoint, said Winthrop & Weinstine attorney Tony Moch. The New York State Attorney General’s Office was looking to register cryptocurrency companies as money brokers, a finding that Moch said the SEC could eventually review. A strong showing by progressive candidates could lead to more regulatory oversight of the industry, he noted.
Moch said community bankers should keep abreast of climate change regulations in the coming year as regulators continue to focus their guidance on larger banks for now.
Addressing the American Bankers Association’s Washington Summit earlier this year, the OCC’s Hsu called on community bankers to start researching the impacts of climate change as regulators address the policies of larger financial institutions. Hsu has said that regulators will start to focus more on the climate risks facing mid-size and small banks once more formal guidance is established for larger financial institutions. According to the ABA, this process could take years.
Hsu said community bankers should evaluate issues related to climate change based on their location. For example, community banks along the Gulf Coast could consider the possibility of Category 4 hurricanes becoming more frequent, or a Kansas City bank could factor in the likelihood of other geographically-specific severe weather events like tornadoes and floods.
Also this year, the FDIC released an outline for how large banks should measure and plan for climate change risks. The agency called on those banks to measure the risks that climate change poses to its operations and assess how the shift to new energy technology can impact their credit portfolios and lending.
In 2023, six of the largest U.S. banks — Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley and Wells Fargo — will participate in a pilot climate scenario exercise intended to increase the ability of supervisors and firms to manage climate-related financial risks. The exercise will include assessments of the FIs under different possible climate scenarios.
Though much of the regulatory focus so far has been on larger banks, Moch said community banks are still impacted because regulators could eventually call into question their farm lending practices.
Community bankers remain wary of offering “buy now, pay later” loans as regulatory pressure remains on the burgeoning industry. However, experts and consumer polling indicates that smaller banks could gain footholds in the industry through both consumer and business lending.
BNPL is viewed as interest-free credit that allows consumers to buy a product and pay the loan back over four installments, the first of which is a down payment on the purchase. BNPL has risen in popularity over the past decade as an alternative form of credit for online retail purchases.
It’s a burgeoning industry: Loan originations increased from just under 17 million in 2019 to 180 million by the end of last year. A recent survey from the data firm PYMNTS.com found that BNPL use more than doubled in 2021 alone. Still, few community and regional banks have adopted BNPL, as they don’t rely on consumer lending traditionally associated with the industry.
Cornerstone Advisors Senior Partner John Meyer sees an opportunity for community banks by offering BNPL loans of less than $250,000 to small business merchants. Those merchants don’t usually partner with larger BNPL providers like Affirm and Klarna and could be receptive to a “pay-in-four” model offered by a community bank provider.
As reported by Protocol, business-to-business BNPL startups are on the rise as the global business payments market hits $125 trillion. The average ticket size is much higher among businesses than consumers, too, allowing payments companies to charge larger fees. BNPL businesses adapt invoice factoring, trade credit, or a combination of both to offer more flexible financing packages than the 30-, 60- or 90-day terms included on a typical invoice.
Those companies are making money by fees included in financing options, rather than explicit interest charges, Protocol reported. Some have a business model similar to traditional BNPL, marketing their offerings through merchants who view it as a good way to increase sales. Others purchase invoices at a discount from sellers.
Though most community banks lack the in-house technology to compete with larger BNPL providers, software infrastructure providers can help smaller banks find their footing in the market, Meyer added. Lending decisioning firms like Zest AI and Synaptics have signed up many credit unions over the last two years, but Meyer noted that the number of official launches remains low. He said community banks considering the move must also ensure their model avoids incorporating bias to comply with regulations under the Community Reinvestment Act, Fair Lending Act and Truth in Lending, a task made more daunting because smaller banks don’t often have the in-house data scientists larger banks rely on.
Studies have indicated that community banks could also find their footing in BNPL consumer lending. The PYMNTS.com report found that many BNPL users are interested in using the option if it was available at banks they have long known and trusted. The report found that number to be even higher among the largest current providers: 79 percent of Afterpay users, 84 percent of those who have PayPal’s Pay in 4, and 82 percent of Klarna users.
Still, many community bankers don’t plan to offer the services. More than 80 percent of banking leaders said they have “little or no interest” in offering BNPL services, according to an IntraFi Network survey of CEOs, CFOs and presidents from 426 banks.