Without a doubt, the economic story of the past year has been the highest inflation in decades. Not only is it impacting current financial and economic activity, but it is dominating the outlook as well. In short, whatever happens with inflation will determine the trajectory of the economy over the next year and a half.
If inflation begins to come down significantly, it will take pressure off the Federal Reserve to keep raising rates aggressively. If instead, it stays persistently high (as it has for the past six months), the Fed will have to keep its foot on the brake pedal of the economy for longer.
How will these economic forces impact your financial institution in the coming year?
Economic Outlook for Financial Institutions
Rising delinquencies, tighter margins driven by an inverted yield curve, and softening loan demand due to higher rates will challenge financial operators.
With the exception of Credit Card (consumer revolving credit) and Home Equity Loans, both consumer and commercial loan demand is softening. Higher rates are cooling off lending activity and will continue to well into next year.
Savings rates have been falling throughout 2022, due in large part to negative real wages and consumers struggling to keep up with rising prices. These lower savings rates are translating into deposit levels dropping, albeit slowly. The outlook is for this trend to continue well into 2024.
The theme for delinquencies for 2023 will be the “great normalization.”
Historically low levels of delinquency over the past years were artificially supported by unprecedented government stimulus. With this ending and inflation eroding savings and wage increases, past dues are beginning their return to normal.
Credit card and auto loan delinquencies are up for the past six months but are still well below pre-pandemic levels. Similarly, mortgage delinquencies remain very low and have only recently shown some signs of beginning deterioration.
As consumer balance sheets worsen and the economy slows, expect delinquency rates to continue their trek back to more normal and sustainable levels. We could see some levels go higher than their pre-pandemic levels during the recession but will not be anything like the credit event we saw 14 years ago.
That being said, there will be regional differences. Some regions of the U.S. will fare better than others and could also see different experiences in delinquency rates.
Tips for Driving Efficiency and Productivity at Your Institution in 2023
As we come into 2023, financial institutions will need to seek ways to drive efficiencies (cost savings) and productivity (doing more with less).
Leveraging technology and process improvements to power greater productivity are vital priorities for businesses in times of economic slowdown. Doing more with fewer employees is a hallmark characteristic of operating during recessions. Because the current economic downturn has been marked by a tight labor market, this guiding principle could be even more important in the coming year.
Partnering with vendors to help reduce operational and labor costs are common steps to keep the expense side of the ledger well-maintained.
Your financial institution may want to consider acquiring talent before the recession ends as labor markets will likely come back to very tight conditions within a couple of quarters of the end of the downturn.
Finding ways to outsource certain labor-intensive functions to those with access to greater economies of scale will not only be a good play to manage costs in a recession but can also help institutions better contend with slower workforce growth and tight labor markets.
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