Looking forward to 2023, the financial services industry will see many challenges, uncertainty, and opportunities on the horizon.
RINGING IN 2023
As we say farewell to 2022, it’s fair to say that many in the financial services industry will be glad to see it go for many reasons. Inflation surged to a 40-year high, job cuts were seen across the banking and fintech sectors, the crypto market melted down with the FTX disaster only the highest profile casualty, while steadily rising interest rates provoked fear and unease for both consumer and corporate borrowers.
The outlook for 2023 seems cloudy, with a likely recession on the horizon as central banks continue to push interest rates higher – boosting borrowing costs with the goal of reigning in price increases. While the twin evils of inflation and higher rates are expected to negatively impact credit quality, it appears that most of the larger banks have the capital to see this through while potentially gaining ground on some of their fintech competitors.
Here are a few observations from our team regarding the landscape for 2023:
Outlook for Banks: Cloudy
As noted, most larger banks are well positioned from both a capital and liquidity standpoint to push through what will likely be a difficult year. Banks produced strong revenue growth in 2022 as they recovered from the pandemic and continuing rate increases by the Federal Reserve. But, following Wells Fargo’s recent $3.7 billion settlement for various violations over many years, the Consumer Financial Protection Bureau has announced its intent to be more aggressive with banks who break the rules. Even though capital levels are high, recession fears will drive banks to reserve more aggressively, reducing earnings and potentially setting off more staff cuts. While higher interest rates should improve interest margins up and down the size spectrum, macro pressure from increased regulation and a weaker economy will certainly inhibit performance this year.
As the Federal Reserve Bank tried to inoculate the economy against inflation, the mortgage sector was the first patient to get sick. In the first week of January 2022, mortgage rates stood at 3.3% and reached 6.5% by year’s end. Mortgage application rates dropped by over 40% from January to December to the lowest level since 1996, and 2023 purchase originations are expected to be about half of what was closed in 2021. While home appreciation has slowed dramatically in recent months as surging interest rates reduced the pool of buyers, the most significant challenge in the market lies with affordability. US homes have appreciated nearly 30% since the beginning of the pandemic. Combine that with mortgage interest rates double that of a year ago, and we expect further shakeout in this sector.
Crypto's Winter of Discontent
As 2022 opened, the crypto sector was brewing with optimism. Fast forward 12 months and the questions have changed from how well crypto will do to how many other Sam Bankman-Frieds are out there and what regulation will look like in the future. In January 2022, crypto had a global market value of $2.4 trillion – today, $500 billion. A core principle of crypto is decentralization, where no one player can affect another. But in a digital-asset environment, connectivity is clearly more extensive than most market participants believed. Meanwhile, investors, who lost money due to mismanagement, market conditions, and fraud, are left wondering how it happened.
Republican and Democratic senators have collectively introduced legislation to put some guardrails on the sector while the SEC is also focusing in, particularly on the exchanges. Chair Gary Gensler is on record as believing that most tokens are unregistered securities being traded on the blockchain. It is only a matter of time before new regulation changes how business is done in this sector.
Buy Now, Pay Later: Expansion
Buy Now, Pay Later continued its growth in 2022 servicing 28 million new worldwide customers and is expected to grow to nearly 90 million users by the end of 2023 according to Insider Intelligence. The flexibility of BNPL remains attractive because the fees are low or nonexistent. The challenge for the providers of BNPL is that capital to fund loans is no longer cheap, and many significant players, including Affirm, Klarna, and Zip, have yet to turn a profit. Meanwhile, many banks and card issuers are developing their own product or utilizing frameworks provided by VISA and MasterCard to ensure they have the ability to compete. The stakes are high as Global Data expects BNPL to reach $600 billion in annual sales by 2026. Afterpay recently announced a partnership with Expedia, allowing customers to break up payments for vacations, hotel stays, cruises, and air flights with no fees. We expect to see more BNPL firms take steps to shore up their model with similar deals and/or create linkages to banks and card issuers who have to participate in this critical growth market.
Data and Network Security – Zero Trust
Network security has become one of the most crucial commodities financial services firms can offer their clients. Historically banks and other enterprises have relied on a cybersecurity model predicated on trusting all devices inside the network perimeter but suspecting all those outside. Zero Trust is a security approach that dictates that no person or device, inside or out, should have access to the in-house network unless explicitly deemed necessary, thus shifting the approach from "trust but verify" to "never trust, always verify." The model is based on strong authentication and authorization for devices and individuals accessing data. Zero Trust is becoming the gold standard, with most users accessing their bank accounts and lending products through mobile devices, we expect further penetration across the financial services industry in the coming year.
Looking forward to 2023, we see many challenges, uncertainty, and opportunities on the horizon. At Profit Insight, we look forward to working with many of you to drive performance in this most challenging of business environments.