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Only a year goes by without major events – whether geopolitical, financial, or something completely unexpected like a global pandemic – that intensely impact financial markets, the economy, and the banks. Last year was no exception, and 2024 is on track to remain challenging. The collapse of Silicon Valley Bank and two other large banks in early 2023 put a spotlight on interest rate risk management. The suddenness and severity of their fall ramped up investors’ and regulators’ scrutiny of banks across the sector, and the risks they face are likely to be a factor in the drumming the bank stocks have taken since. Meanwhile, banks were already dealing with significant risks, including cyberattacks and frauds, depositors shifting funds to higher-return investments, and the effects of the pandemic on both their investment and loan portfolios. Rather than finding resolutions, those risks only seemed to grow last year and have become more complex these days.
That trend is clearly enduring into 2024, with risks like cybersecurity amplified by the rapid adoption of artificial intelligence (AI) and, in particular, generative AI technologies. The greatest worry expressed by bankers and experts, however, appears to be the ambush of regulatory changes. Even those not going into effect well after 2024 are likely to keep bankers up at night in the year ahead as they analyse the potential operational and strategic impacts and how to address them. The biggest stress is what’s on the horizon, more than what bankers are dealing with immediately.
Shelling of regulatory scrutiny and rules: The regulatory rules and issues just keep layering on top of each other, with little apparent coordination among the various regulators or consideration about what their combined impact will be. In the meantime, banks should prepare systems and train staff to comply with the requirements, and given the complexity, even prepared banks can face compliance risk. Banks may need to continue to invest a significant amount of time and talent to ensure that they meet their compliance obligations.
Among the most significant, even for small banks, it essentially levies on banks’ small business lending the type of reporting, data collection, and hygiene currently required for consumer credit.
Nevertheless, banks will have plenty to do this year, including preparing their systems, software, and other changes necessary to be compliant. Small business lending typically occurs in different divisions in a bank, ranging from Small Business Association loans to equipment financing to credit cards, and banks will have to collect normalised data to report annually. The rule can dramatically reshape small business lending because institutions may not be able to price the risk like they do today. The new requirements may be problematic for smaller banks operating in more confined geographical markets, since pushing to reach certain metrics may lead to greater credit risk. Plus, banks are increasingly competing against nonbank credit providers not subject to the rule. When only banks have to hit certain metrics, it can create risk in the banking sector.
Also on the horizon is the banking regulators’ Basel III “endgame” proposal, which was issued in July last. In a September report, EY says it “will fundamentally alter how banks with over $100 billion or more of assets approach risk-based regulatory capital and capital management.” The proposal will likely increase the banks’ risk-weighted assets, the report said, and require smaller ones to enhance their risk data and technology capabilities and controls.
Higher rates present-day a range of risks: It boils down to another manifestation of interest-rate risk, which has really held back the regional banks. Pointing to ongoing higher interest rates increasing deposit costs and clutching bank margins, as well as potentially resulting in more losses if fixed-income investments are not kept in held-to-maturity accounts. In addition, there’s been significant interest-rate volatility over the past few years. Business picked up significantly soon after March’s regional bank failures and has gained momentum as clients seek to protect themselves against different scenarios, often using pay-fixed swaps either to extend liabilities or shorten asset duration. The higher cost of deposits, in some cases prompting banks to let them run off, has resulted in increasing challenges that can create business risks. Say, a client that had originated a sizable loan faced difficulties in finding bank participants to share in the credit. Even during the crisis, was saw it did not hear as much about banks slowing down loan originations because of liquidity.
Emerging credit issues: Just as banks’ margins are tightening, their loans are showing signs of deterioration. Delinquencies for both consumer and commercial debt remain relatively high and will be rising. That’s to be expected in an economy facing headwinds.
AI and Fraud Supercharged: Elevated deposit rates will push banks to grow fee income and cut costs, but overdoing it can create its own risks. Wholesale cost-cutting efforts should not cut into investments in technology and IT talent that are warranted both to protect the bank and grow its business. Cybersecurity continues to rank as a top risk across the world, and the rapid commercialization of AI has provided cybercriminals with a more effective tool both to penetrate banks’ systems and to perpetrate scams. It has seen first-hand several scams involving phone calls that are using voices created by this technology. Check fraud remains a major risk for banks, but top-of-mind is the weaponization of widely available generative AI to accelerate fraudulent schemes, whether to fool voice or knowledge-based authentication procedures or to draft and send out phishing emails at scale. Demand for expertise to fortify a bank’s systems against cyberattacks has become increasingly hard to find and expensive, and AI is adding another complication. AI, which has long been used as a tool in compliance and risk management, has its pluses, and his bank is looking at generative AI to speed up the coding process to improve its systems as well as to generate letters and communications to clients much more quickly.
Shocks of geopolitical from out of the blue: Nobody predicted the natural downturn or the extent of last year’s bank upheaval, so it’s unsurprising that bankers are worried about the risks in 2024 that nobody expects. The economy is headed and the factors that could impact and this is a very interesting time in the economic cycle, and it’s unclear whether there will be an economic soft or hard landing, and if it’s the latter what steps can be taken to reverse it. Inflation tends to mask companies’ issues because everybody can raise prices at the same time, but when inflation falls, only the stronger brands and companies will maintain market share. So it would probably see delinquencies and defaults pick up. Perhaps harder to hedge, but especially relevant today, are the extreme risks that could emerge from the wars in Ukraine and Gaza, tensions with China, or, as is often the case with what amount to catastrophic events, from completely unexpected corners.
The writer is the Company Secretary, City Bank PLC
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