Banks increasing buffers to prep for higher rate of defaults

Deloitte Center for Financial Services recently published a report on the 2024 Banking & Capital Markets Outlook. They stated that “banks’ strategic choices will be tested as they contend with multiple fundamental challenges to their business models.” 

Retail banks face several challenges in the coming years, including higher funding costs, slower loan growth, declining loyalty, and increasing customer defections. Despite stabilizing deposit flows, containing deposit costs may remain difficult, and new regulations on capital and liquidity requirements will be introduced. Weakened household finances will put further pressure on banks’ loan books, leading to credit tightening.

To address these challenges, retail banks must focus on fortifying customer relationships and increasing their share of wallet. Personalization will play a crucial role in demonstrating the lifetime value of customers. However, banks may struggle to customize products and services due to legacy systems and limited ability to leverage customer data for tailored experiences. Implementing advanced modeling tools that generate predictive insights and offering real-time financial advice can help overcome these limitations. Banks should also explore emerging technologies to enhance risk management, compliance, operations, and customer experiences. For instance, generative AI can expedite credit risk assessments, notify mortgage applicants of missing documents, and boost the productivity of customer-facing teams.

Retail banks currently face a convergence of pressures, including higher funding costs, competition from digital banks, and increasing demand for personalized services. The rise of embedded finance and open banking further reshapes the retail banking landscape. Customers now have more options and find it easier to switch accounts and diversify deposits across various platforms.

While deposit outflows have stabilized after a turbulent first half of 2023, challenges persist. Higher interest rates reduce borrowers’ appetite for new loans and refinancing, leading to slower growth. Delinquency rates for auto, credit card, and consumer loans have increased, prompting banks to prepare for a higher rate of defaults by increasing their loan loss provisions. In 2024, banks may tighten credit further and consider selling subprime auto loans and riskier home equity loans to strengthen their balance sheets.

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