In this week's Purposeful Banker, Alex Habet takes a look at some of the latest headlines in banking news to see what the buzz is in the market and what's top of mind for bank leaders.
Hi, and welcome to The Purposeful Banker, the leading commercial banking podcast brought to you by Q2, where we discuss the big topics on the minds of today's best bankers. I'm your host Alex Habet.
We've been talking a lot about banking throughout the years. It's a banking podcast, after all. You've heard from leaders and experts from our company. You've heard from influencers out in the field. We've always tried to bring a little bit of a sprinkle of current events, especially as they were topical in our episodes, but we wanted to do something a little bit different this time with today's episode and really shine the spotlight on what's going on out there in the world.
Here at Q2, we keep really close tabs on what's going on in the financial media or in the news. Understanding the pulse of the banking world is what guides us for our day-to-day business decisions here at the company, and we track a lot of topics. We sift through a lot of noise. Today's episode, we want to cut through the noise and share some of the more interesting things that we're keeping tabs on. Hopefully, there's something new here for you to share with others.
While there's a ton of directions we could go with this, we really wanted to narrow this down to a bite-sized sample. We've selected seven stories and articles from across three different categories: first being recent bank earnings, the second being regulatory changes, and the third, of course, being a healthy dose of AI. You can find all the relevant links in the episode description below.
Starting with earnings, our first spotlight article comes from the Wall Street Journal and an article titled “Regional Banks Had Another Ugly Quarter.” Now, of course, regional banks have experienced sharp declines in profit during the most recent quarter, especially when you compare to the prior year. This is not isolated to just a few banks. In fact, several citing 50%, some even higher drops in income and some are even swinging to a loss. The economic outlook certainly remains uncertain for these banks.
Now, the Fed could provide some relief with a pause in aggressive inflation-curbing moves, but the timing is unclear, further complicating the planning and forecasting that happens at each of these banks. As a result, regional banks of various sizes are anticipating a decline in net interest income for the entire year. The higher interest cost for deposits significantly has affected regional and community banks, which find it more challenging to absorb these costs compared to their larger counterparts.
This has only heightened since the crisis of early 2023. Regional banks are trying to recover by downsizing. They've also had to set aside significant funds for special FDIC fees and potential loan losses. Now, of course, the real estate sector poses additional concerns, especially with a high concentration of commercial real estate loans that may become problematic. That said, the article did not paint only bleak news. There is a ray of light saying the lack of consistent bad news is actually good news.
Which brings us to the second article that we're sharing. It's a blog post by Martin Tillier published on NASDAQ's website. With the collapse of Silicon Valley Bank and other regional banking angst occurring only six to nine months ago, you're not seeing it as much covered in the financial media. It's not everyday headlines like it was, but the post did confirm what the first article we discussed mentioned, revealing the challenging quarter and notable profit decline specifically in the regional banking sector. And among the top six regional banks by market cap, there was a split in performance. Half missed, half beat earnings-per-share estimates, but all saw significant profit drops compared to the prior year.
This decline in regional bank profit highlighted an ongoing divide in the U.S., which is actually separate from the wealth gap. The financial world, if you include the stock market and the large banks, they all appear pretty healthy. But regional banks, that's where the post is arguing that it's operating in the real world. It faces challenges like struggling commercial real estate and the impacts of inflation.
The disconnect between the stock market and the real economy is becoming increasingly apparent, with the author suggesting a potential market correction to align with the underlying economic realities.
Those first two examples up to this point spotlight earnings issues. Let's turn to the third article in this segment, which looks at the 2024 outlook as published by Deloitte. Now, Deloitte offers their key message across a few different areas, beginning first with economic and regulatory challenges.
With disrupted forces such as higher interest rates, a reduced money supply, assertive regulations, climate change, and geopolitical tensions, everything is front and center. Now, banks are generally more stable but will encounter testing times regarding their revenue models with modest organic growth, which will compel them to explore new value sources in a capital-scarce environment impacting investment banking and trading sectors.
All this has led to a reassessment of banking strategies focusing on changes in capital, liquidity, and risk management. Different segments within the banking sector—such as retail banking, consumer payments, wealth management, corporate and transaction banking, and investment banking—each face their own unique challenges and opportunities. These range from managing higher funding costs to slower loan growth in retail banking and to adapting business models and investment banking amidst changing market dynamics.
Which is actually a very nice segue into the second category of articles that we're going to cover in today's episode, focusing on the regulatory front. Now, The American Banker published an article titled “The Walls Are Closing in on Basel Capital Reforms.” A diverse array of groups, including consumer advocates, community organizations, banking industry representatives, they're all expressing strong opposition to the Federal Reserve, OCC, and FDIC's assessments and implementation of the final aspects of the Basel III Accords.
This widespread discontent suggests a significant adjustment or even a complete re-proposal of the rule may be necessary. In fact, the Bank Policy Institute and the American Bankers Association have detailed their objections in a comprehensive document, I believe it's 300 pages long, highlighting issues like overlapping regulatory requirements, unclear risk weightings, and the proposal’s potential to hinder credit availability, especially in low-income communities.
The proposal has drawn criticism for potentially increasing the risk ratings for high loan-to-value loans, which could disincentivize banks from lending to those lower-income and minority borrowers. Concerns also extend to the rule's potential impact on mortgage lending, credit availability, and the broader economy. The industry's intense opposition includes threats of legal action. It represents a significant shift in how these organizations are confronting regulatory rules.
This strategy may lead to delays in finalizing the rule or compel the regulators to reconsider their approach entirely. With such an extensive opposition, including from The Federal Reserve Board Governor Waller advocating for the withdrawal of the proposal, there is a growing likelihood that the rule will undergo substantial revisions. The regulators may need to scale back the more stringent aspects of Basel III standards to align more closely with international minimum standards.
The second article that we want to bring to your attention on the regulatory front comes from BankingDive.com in an article titled, “Bank CEOs Outlined Perceived Dire Consequences of Basel III.” This is very much a continuation of the prior article. The CEOs of the nation's largest bank sounded off to the Senate Banking Committee in December, warning that the proposed Basel III Endgame standards could lead to reduced banking services and higher charges to consumers.
CEOs like Citi's Jane Fraser and Goldman Sachs' David Solomon expressed concern that the new rules could shift activities to less regulated non-bank sectors, increasing risks and putting U.S. banks at a competitive disadvantage internationally. In fact, Jamie Dimon took it even one step further, criticizing regulators for a lack of thorough economic analysis before proposing the Basel III Endgame, suggesting that the process was not thoughtfully executed. Those are fighting words. We're now waiting to see which way lawmakers and regulators will move as a result of all of this dialogue.
Which brings us to the final category of news for today's episode, AI and banking. Of course, it's a topic we've covered extensively in the past. The first article in the space comes from S&P titled “AI and Banking: AI Will Be An Incremental Game Changer.” By the way, I couldn't agree more with the title of this article.
As banks are increasingly integrating generative AI—which promises to enhance earnings growth, decision-making, and risk management but also bring new risks and costs to each of these institutions— testing and adoption are anticipated to accelerate over the next two to five years, with benefits likely to be incremental. Banks have actually always been early adopters of AI for improving various processes, having been used for operational simplification, cost reduction, enhancing employee capabilities like fraud detection and financial forecasting.
Now, banks are exploring various generative AI applications ranging from customer service automation to advanced risk management tools, with approaches varying based on the bank scale and investment capacity. One of the things that this specific article does, which I love, is provide some interesting use cases and applications of AI in banks that you've all heard of across a few different categories. For example, for Barclays, fraud detection using AI, they are preventing fraud by predicting potential instances, using real-time monitoring of merchant payment transactions.
They're not the only ones who are doing this. I would actually argue this is probably one of the more common applications. It's easy to see how this has become one of the more popular ways that AI is being leveraged in banking today. Santander, specifically in their corporate and investment banking decision, developed an AI tool called K-ROS that shows how a corporate client could be impacted by economic events, creating prediction patterns that enable employees to make more informed investment and lending decisions.
Bank of America is leveraging AI and research analysis in a platform they call Glass, which helps sales and trading employees uncover hidden market patterns to anticipate client needs by consolidating market data across asset classes and regions within the bank's in-house models and machine learning techniques. It's an aggregator of sorts. Then finally, Discover Financial Services is using AI for credit underwriting. Through a partnership with an AI software provider, the bank can provide improved credit underwriting and reduce default rates.
And now we come to the last article that we're sharing in today's episode. It's another one from The American Banker. In an article titled, “Call Summaries, Copilots and Cores, the Use Cases for Generative AI,” Penny Grossman interviewed Michael Abbott from Accenture. According to Abbott, GenAI significantly boosts productivity in banks by automating routine tasks like summarizing call center interactions and streamlining loan compliance, potentially increasing efficiency by 20 to 30%.
This is certainly high interest, but even more cautious implementation. With 49% of financial firms adopting GenAI and 19% already benefiting, banks remain cautious in deployment, focusing on internal uses and human-in-the-loop models to mitigate risks like data hallucinations and privacy violations. Banks are keen on implementing GenAI responsibly, adhering to existing frameworks to prevent biases and unintended consequences, using AI to augment rather than to fully automate processes.
GenAI is also being used to develop custom solutions like personalized customer service scripts, offering significant revenue generation potential that far surpasses the cost savings from operational efficiencies. The use of GenAI as a co-pilot is also becoming more common practice, providing humans with AI-generated solutions and insights while retaining the oversight and decision-making. It's why you hear us talking so much about A&D here at Q2.
GenAI has a potential even for legacy systems by enabling the reverse engineering of legacy code into modern architecture, although this process is not fully automated. It requires human intervention. It allows banks to extend the life of even their legacy applications without relying on the knowledge required to maintain legacy coding languages to maintain these systems. Banks are adopting a cautious, aggressive approach to GenAI, being proactive in internal adoption and experimentation while ensuring compliance with standards and customer impact considerations before full-scale implementation.
And now as we wrap up our news recap here, we hope this provided you with a nice, quick summary of what's going on out there. We will continue keeping tabs, filtering out the noise, and providing you with periodic updates in the future. That's it for this week's episode of The Purposeful Banker.
If you want to catch more episodes, please subscribe to the show wherever you like to listen to podcasts, including Apple, Spotify, Stitcher, and iHeartRadio. And if you prefer a video version, you can also catch us on YouTube. As always, let us know what you think in the comments, and you can also head over to Q2.com to learn more about the company behind the content. Until next time, this is Alex Habet, and you've been listening to The Purposeful Banker.