As the year unfolds, it will be crucial for banks to adapt to upcoming challenges and seize potential opportunities for growth and stability.
As the world entered a state of recovery following the pandemic and the impact of geopolitical tensions, the banking sector was starting to see profits once more. However, with some negative impacts dragging on, households have witnessed a rising cost of living while businesses find it more difficult to survive in the current environment. The result has been an increase in loan defaults and well as a higher risk of more borrowers defaulting on loans. This dilemma in the banking sector, in addition to the ongoing war in Israel, is set to continue, as globally, banks are expected to face a negative outlook in 2024 according to Moody’s.
The credit rating agency highlights that the tightening of monetary policies by central banks, along with several other key factors such as higher funding costs, lower loan growth, and reserve buildups, are expected to contribute to the challenging environment in 2024. Due to the tightening of monetary policies, the banking sector’s operating environment is expected to deteriorate as central banks will have to reduce rates thus affecting interest rates. The result is expected to be a decrease in GDP growth in 2024.
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Apart from seeing their profit from interest rates being affected, the sector will be affected by geopolitical and climate risks. For instance, the conflicts in the Middle East and Europe are expected to continue eating into the profits of the banking industry. Loan quality is also to be affected, as the world faces an unemployment crisis, with millions lacking opportunities due to businesses shutting down, loan performance is likely to weaken. Households will not be able to service their loans thus leading to an increase in defaults.
Funding and liquidity will also not be spared. As market funding increases, deposit growth is expected to take a hit, as many people avoid banking institutions in favour of other methods of investment. This will also lead to a lower loan growth, limiting funding strains. Markets are also expected to face further foreign currency shortages.
This will eventually result in a decrease in the profitability gains that banks were experiencing since the world entered a phase of recovery. Higher funding costs will decrease banks’ net interest margins, and 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.
Despite the negative outlook, capitalization is expected to remain stable. For instance, banking institutions in developed markets such as the U.S and Europe are expected to build capital due to regulatory cushions. According to Felipe Carvallo, senior credit officer at Moody’s Investors Service, funding and liquidity will pose challenges, but capitalization will remain stable, benefiting from organic capital generation and moderate loan growth.
The credit ratings agency predicted that banking institutions in the regions of Africa and Middle East would be among the most affected as operating conditions for these banks are expected to remain difficult. However, despite these challenges, the agency forecasts that African banks will be able to withstand and adapt having been accustomed to navigating such turbulent periods.
Countries such as Kenya, Egypt, and Tunisia face large refinancing needs, including foreign currency. This makes them particularly exposed to debt rollover risks or higher interest rates that could further weaken debt affordability. On the other hand, others like Ghana have successfully completed their local currency debt restructuring in 2023, but foreign-currency debt restructuring remains pending. The creditworthiness of African banks is closely tied to that of the sovereign, with Egypt, Kenya, Ghana, Tunisia, and the West African Economic and Monetary Union (WAEMU) having the highest sovereign debt exposure.
The agency also predicts that African banks are likely to maintain their capitalization levels and gradually implement stricter Basel capital regulations. In the continent, profitability is expected to improve with higher interest rates. Having shifted to relying on deposits in local currency should help the banking industry in Africa as local-currency funding is projected to remain stable. However, raising funds in Eurobond debt capital markets may become more costly due to tight global conditions. Foreign-currency shortages will continue to pose risks to the liquidity of African banks as witnessed in the start of 2023.
Moody’s negative outlook serves as a warning to the banking sector. As the year unfolds, it will be crucial for banks to adapt to these challenges and seize potential opportunities for growth and stability. If not, 2024 will be a ruthless year for the banking sector’s overall performance and profitability.