Banks’ profitability to decrease over the next year and to return to current levels in 2026

Banks’s profitability will remain subdued over the next year, because of an unprecedented mix of factors including Russia’s invasion of Ukraine, supply chain disruptions, inflation rise, tightening monetary policy across the world and potential recession or stagflation in certain economies, but it is expected to improve until 2026 and reach the current levels of return on assets, according to the Deloitte Banking and Capital Markets Outlook for 2023.

The direct and indirect effects of the global economy will be felt disparately across the global banking industry, as they will depend on the economic growth and interest-rate environment in the country and in the region, on the bank size, capital levels and business models, the report also indicates. For instance, large, well capitalized and diversified banks are expected to be more resilient over the next years. Also, the report highlights that gross domestic product (GDP) growth is strongly tied to banks’ performance measured by return on assets in both advanced and developing economies, so a country’s GDP contraction will most likely be accompanied by a decrease in the profitability of its banking system.

Although consumer and corporate balance sheets seem to be depleting, the report reminds that, generally, banks have strong capital buffers and adequate liquidity as of the third quarter of 2022. On the other hand, the cost of funding, whether deposits or other forms of borrowing, will most likely stay elevated for the following years, according to the Deloitte report.

As they anticipate an economic slowdown, banks have built-up reserves against potential loan losses and have become stricter in their loan underwriting policies and, the report highlights. For instance, banks in the Eurozone have tightened their underwriting standards as of the second quarter of 2022, a trend that is expected to expand across all European banks. Also, in such a volatile revenue environment, the focus on cost control becomes paramount, as well as on increasing efficiency, whether through better use of capital, advanced technologies, branch footprint rationalization, creation of service centers in low-cost locations or increased reliance on service providers. Also, the report estimates that workforce optimization will become a focal point in 2023.

Retail and corporate banking will be impacted in different ways, according to the report. Due to higher net interest income from rising rates, retail banks are expected to cope well with the 2023 challenges such as higher rates, inflation and lower growth. The retail banking industry is expected to be influenced positively by evolving customer preferences, demand for personalization and evolution of interest rates, but factors such as the evolution of the housing market and the cyber risk and financial crime will most likely impact it in a negative way.

When it comes to the banks serving businesses, they enjoy a loyal client base, but will most likely face increased competition and pressure to improve their client service model, as corporate clients demand customized digital solutions, data-rich solutions and specialized advice. The corporate demand for capital investments is likely to decelerate, but, on the other hand, the demand for working capital could remain robust, the report shows.

“Although the challenging current macroeconomic environment could negatively impact sustainability-linked loans, the need to act on climate change is a great opportunity for banks to finance their corporate clients’ transition to net-zero carbon emissions. Banks need to integrate climate risk into the credit risk life cycle in order to ensure a more effective risk management. This implies obtaining clients’ ESG (environment, social, governance) data and establishing internal standards and processes to assess emissions in credit portfolios against set targets, but also training bankers to understand their clients’ ESG positions”, said Dimitrios Goranitis, Banking and Capital Markets leader, Deloitte Central Europe.

Another opportunity for banks for the next two to three years is embedded finance, which refers to the integration of financial services into the backend of nonfinancial third-party platforms, which, according to the report, is set to explode, with expected revenues reaching up to US$230 billion until 2025, which accounts for a tenfold increase. For example, banks could supplement shopping experiences with personal financial management tools or integrate credit options into health care apps.

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