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Beyond the Fed Hike: The Business of Banking in 2016


US banks are at an inflection point after the Federal Reserve's decision to raise its benchmark interest rate for the first time in nearly a decade. Goldman Sachs Research's Richard Ramsden discusses front-burner issues for the industry in the year ahead, including the pace of future hikes, the rise of new entrants and the growing imperative for banks to stay ahead of technological innovation.

This podcast was recorded on December 17, 2015.

All price references and market forecasts correspond to the date of this recording.

This podcast should not be copied, distributed, published or reproduced, in whole or in part. The information contained in this podcast does not constitute research or a recommendation from any Goldman Sachs entity to the listener. Neither Goldman Sachs nor any of its affiliates makes any representation or warranty, as to the accuracy or completeness of the statements or any information contained in this podcast and any liability therefor (including in respect of direct, indirect or consequential loss or damage) is expressly disclaimed. The views expressed in this podcast are not necessarily those of Goldman Sachs, and Goldman Sachs is not providing any financial, economic, legal, accounting or tax advice or recommendations in this podcast. In addition, the receipt of this podcast by any listener is not to be taken as constituting the giving of investment advice by Goldman Sachs to that listener, nor to constitute such person a client of any Goldman Sachs entity.

Copyright 2016 Goldman Sachs. All rights reserved.

This is an unofficial transcript meant for reference. Accuracy is not guaranteed.
This is exchanges Goldman Sachs, where people from our firm share their insights on developments currently shaping markets industries in the global economy, objects, seaward, global, had of corporate communications, hurt the firm with the? U S: Federal Reserve, raising its benchmark interest rate for the first time and nearly a decade. Twenty sixteen is shaping up to be a pivotal year for the financial services industry, richer Ramsden, who covers banks not named Goldman Sachs for Research division, is here discuss the save the industry today and what to watch for in the year had Richard welcome to the problem of a hug me Richard is lotta. Talk right now the future of finance the industry's facing increase competition from newcomers and the field? Intense regulatory pressure of the last several years.
And a shift in FED policy in the wake of that shift in policy in these new competitive pressures. How'd, you characterize the stated, the banking industry today, the banking industry over the last five or six years, as has gone through some of the most profound changes that I think we ve seen in and more than fifty years in the wake of what happened in two thousand and eight, there was a lot of regulation that was put in place and the banks have really been. To that over the last five or six years. If you look at the banking industry today, I think it is fair to say that it's never been more stable relative to at any point of a lost thirty or forty years and a few interesting metrics that I think stand out. If you look at the amount of carbon in the banking industry it's more than doubled since globally is in the EU and the? U S yet, but the capital levels across banking on the streets around the world have gone up. If you look at the amount of liquidity suggesting a cash that the banks have sitting on their balance sheets, it is more than tripled, and if you look at the types of loan portfolios, the banks hold today.
They look quite different to ten years ago in that they tend to be much more prime. In nature, they tend to be skewed towards either investment, great corporates or higher net worth type individuals You seen a lot of changes in the composition of bank balance sheets and I think that put them on a much more stable footing. The biggest issue the banks have been dealing with over the last five years has been lacking. Growth. So if you look at revenues in the banking industry that pretty much declined every year since two thousand and nine is up the function of all that stability and cautious, yes and conservative encroached about she's got a hundred percent right. So I think what happened? Is you increase. The amount of capital reduced the amount of risk, and that has come really at the expense of revenues and revenue growth. But that also being compounded by the fact that interest rates have been close to zero
as part of the last seven years at the most simple level, the way their bank makes money? Is they take deposits from someone like you? They pay you something for those deposit. And then they go out and lenders deposits to someone else. So, what's up, and as interest rates have gone down, is they have paid you less on your deposits as I have gone out and invested those deposits either in loans when other securities, the yield on the security, the loans have come down dramatically so over the last six or seven years, the amount of interest income that the bank's generate has dropped by almost a third So that's what a lot of pressure on the revenues and on the profitability of the banking industry. Goldman Sachs Research just hosted its annual financial services conference here in New York, there were represented from seventy the most prominent firms in the industry, including all the major banks. What did you hear about
operating environment that their expecting for next year, especially in the backdrop of this slight increase in interest rates that that was a very big thing of the conference, and I think almost every bank presented said that we are starting to see an improvement both in confidence levels both among small businesses, but also consumers, but also activity level. So I think a few interesting things that stood out one of the bank said if you look at payments, that they see across the platform and keep in mind, banks have a really good pulse of the economy, because they see all the spending that taking place on credit cards among debit cards. They said that look if you are just for the fact that concern
was a spending less on gas today, because gas prices are lower, consumer spending is up somewhere between five and five and a half percent relative to where we were a year ago, especially given that that's a major component of services economy like the? U S is hugely important and I think that the surprise to a lot of people over the last few years has been that the economy has been improving gradually, but consumer spending and consumer lending the willingness for consumers to borrow, has really been a lot lower than you would have anticipated this being real risk of russian amongst consumers. Just to give you one number that thinks interesting. If you look at the amount of cash that is sitting in consumer checking accounts, it is seventy five to a hundred percent higher than where it was in two thousand and seven consumers are sitting on a lot more cash. They have the lowest level of leverage in their balance sheet, but you ve seen in fifteen years and despite the fact that those being this huge windfall effect
from love out long guy says they're propensity gonna spend that has actually being quite love recited. The good news is that that does seem to be changing. You are starting to see consumer lending pick up. You are starting to see consumer spending pick up and in turn I think that is gonna, be put an engine of growth for the. U S economy going into next year. In a way we saw the same cycle on the corporate side in three years after the crisis corner. It said Billy rejected their balance sheets much safer and People are wondering where the activity and then the last year and a half we really seen corporates, can allow more aggressive, take on risk the growth and by law they said, but the only thing holding us back is this lack of consumer spending. So you could see more virtual
cycle. That's exactly right and I think what s interesting is. You initially saw a pick up in larger corporate activity, but small business activity really took a long time to pick up and again, I think what stood out this year is that, especially over the last six months, you seen a real pick up in small business lending and small business activity when you asked the nice at. Why is that happening? I think is happening because a lot of smaller companies have put off cap acts, decisions or investment decisions for a long period of time, because they have been concerned about the parliament, but it's getting to the point where they count delay those decisions any further. I you know the truck they have is falling appalling part or they have no option other to expand the amount of manufacturing capacity, because demand is starting to pick up. That, I think, is a very good site so
the conference in the wake of the feds decision, alot of investors and executives, are moved from worrying about whether the federal tighten, how quickly will Dinah what the pace is and what is at stake for the banks there and how they thinking about the the velocity the feds increasing rates, so changing interest rates has a dramatic impact on both revenues for banks, but also for a whole bunch of other risk metric. So the simplest level again as interest rates ought to go up. Banks who have all this excess cash can invest that cash are too high. Real interest rates have just gone on twenty five and fifty basis points rather than getting zero on your cash monogamy. Twenty five fifty basis points, and it doesn't cost you anything more to do that. In addition, you ve got a whole bunch of loans that sit on your balance sheet. The price
off. Prime rate. Libor rates and interest rates go up those two three price automatically, so you will start to see margins expand. You will start to see some revenue growth and that's obviously going to help the industry now there's a couple of things that hurt the industry. The first is as interest rates go up, loans become more expensive, which in turn makes it at the margin more expensive for borrowing to repay or service that that so there is a risk that his interest rates start to go up, that you start to see bad debts on loans creep up from very, very low levels and secondly, as interest rates go up, the cost of borrowing is gonna, go up as well, which in turn could impact loan demand. So you could, at the margin, see corporates opt to either use cash both optimal. the way that they run their business so that they don't care those high borrowing costs, so loan demand could be negatively impact. It especially A lot of the bigger corporates of refinanced stay out these rates, as far out as they could
Think of the obvious place to look at is gonna, be what happens to the mortgage market. They have had a massive refinanced wave within mortgages, borrowing costs thirty. A mortgage have been at all time loaves as interest rate start to go up. There is going to be an impact on the cost of borrowing for mortgage, isn't it. That's gonna impact the housing market in some way Richard you talk a little bit about the impact of lower gas prices on the american consumer in the economy and that were beginning to see optics and consumer spending from that windfall
let's look at the lower commodity prices. Overall, what's the impact of commodity prices coming down as dramatic as they have on the financial sector as a whole, but also politically banks? As we ve talked about the impact on consumers is positive. I mean the windfall effect from lower energy prices has been really very significant in terms of the amount that is added to that disposable income for consumers. On the corporate side, obviously companies which are directly exposed to energy are starting to see increased levels of grass and the oil prices down over sixty percent over the last year. That's had a real impact on the revenues of these companies and the office. I haven't been able to reduce expenses to offset that decline
Now, as a result of that, we are starting to see some stresses in energy portfolio, so was starting to see a mild pick up in bad debt, so that companies that cannot, we pay the debt that are taken on, and we have also started to see. Banks start to reserve against the probability of bad debts continuing to rise. The reality, though, is that the banks exposure to energy directly is quite small, the average bank in the. U S has less than two percent of the loan portfolio directly exposed to energy companies, which means that ninety eight percent,
exposed to other industries, many of which are frankly, benefiting from lower energy prices in the form of lower import prices. Another spot, a weakness around the world has been emerging markets in the prospect of rising use rates is really the negative cycle for a lot of emerging markets, along with lower commodity prices, how our banks, responding to that politically those big multi national banks and operate emerging markets. So we most banks in the? U S: Rashid Domestic, ninety percent, plus of revenues of the? U S banking industry generates actually come from within the Eu S. You do have a few
thanks which have got exposures overseas and some of the emerging markets, and what we ve seen over the last few years is that some of those markets have got a lot more difficult. So Brazil is obviously going through a very protracted and a very deep downturn. Russia, because they are very energy dependent, has also started to go through a recession and in turn that has slowed growth in those regions. In turn, I think that has impacted the revenue growth for some of those banks and it has impacted credit quality, but those exposures tend to be pretty small in the overall context of those banks. Let's talk about technology, banks have always had to adapt because their consumer facing businesses and consumers are using new technology. How do you see that playing out over the next several years? And how do you see banks adapting to the changes in how people live and you
technology. The reality is that technology has played a very important role in the banking industry for the last fifty years. But if you just take a trip down memory lane in the early nineties eighties, when ATM technology was introduced, everybody thought that that was going to be the death of a bank teller. In actual fact, over per tonne even though a number of items in the? U S, banking, ass, we went through the roof. The number of tellers only decline marginally than in the late nineteenth nineties. Everybody was very focused on the intimate everybody thought that the internet was gonna, put a lot of banks out of business. The banks are actually very early adopters of internet technology, they incorporated into their offering that they gave to their clients and very soon just became enough tradition channel, it didn't really put a lot of banks out of business. More recently has been a lot more focus on mobile type technologies,
The banks are adapting very quickly. There were adopted very quickly, and I actually think the banks have been very surprised at the take up. In terms of some of the mobile technologies, one interesting stat for those of you who bank at some of the larger institutions, you can now take a picture of a check and deposited remotely without having to go to the branch that technology was only introduced in two thousand and ten. Roughly sixty percent now of checks are deposited remotely through people taking a picture of the Mama on their Iphone and depositing them without having to go to a branch of that type of ramp is historically unprecedented. Now, in turn, what that is doing is it is banks to go back and rationalize some other fixed costs, distribution network. So you off for the first time in history, seen a decline in the number of branches, a decline in the number right here. Comes banks are moving too much smaller,
branches, service centres service, and so that it really is trading? I think the way the bank's looking at this is a win win. It is allowing them to lower the costs, which in turn, allows them to give a better deal to consumers incorporates. But, frankly, I think consumers really prefer this technology, it's a lot more efficient and in many cases, if a lot more secure, because a things like the fingerprint technology, so the bank's heavy varies. wrong incentive to adopt this technology? The new wave of ATM machines that will be rolled out well, A whole range of gonna know your client technologies embedded in who at whether its iris scanning of fingerprint type technologies, which again will allow the bank to do higher value transactions with you without you being physically present, because the confidence that the person you claim to be being the person you actually ours is that much higher. Talk specifically about blockchain technology, as many of our listers will know, blockchain has its origins in Bitcoin the digital currency, but many
On the banking industry and outside or focused on Bitcoin Blockchain, seeing it as a new way to increase systemic stability and add real time. Transparency too many financial transactions proponents think it could revolutionise that part of the industry. How do you see a playing out, launching potentially could be one of the more important technologies- the banking industry, adults over the next few years- and as you talked about Blockchain- something that came out of Bitcoin one of the issues the banking industry has had over the last few years in the time it takes to settle a transaction is a lot longer than I think people would like I'll. Give you an example of this if we as a farm enter into a dollar yen transaction with, I am thus selling dollars and their buying Yan. That transaction takes roughing nineteen hours to effectively saddle. So everyone doesn't get
for ninety now is now. Why is that the speed of execution? They asked D minimised, but actually settling time. Yet a lot is a day. The transaction is instantaneous, but it takes mighty. Now is for everybody to get their cash because of time, differences and because of other frictions. Blockchain technology potentially offers the ability to satellite transaction instantaneously, which means that you enter into the transaction, you clear, the transaction within seconds, and I think that is a very, very valuable technology both for clients, but also for the banking industry, because what it means is that the not risk for ninety hours and for those nineteen hours there is the potential that we asked biking rates divergence in the rates could end up, leaving the bank's holding COS. Yes, that technology could really improve the efficiency for banks, as was improve the customer experience and I think, Banks are investing a lot of time and money in understanding that,
energy, and they are very keen to adopt at one of the things you have to realise that the bar for the industry to adopt new technologies is very high. The banking industry is unique in one respect, which is that You cannot be right. Ninety nine point, ninety nine percent of the time. You need to be right, a hundred percent of the time just because of the number of transactions that are processed and the value of those transactions. So these types of technologies typically only get adopted once you can really prove that bust, but the secure and they're gonna do what think they gonna do without any unintended consequences, but I do think it's are you will hear a lot more about over the next three or four years? So all this talk about Ups in disruptive technology, you think the banks are gonna move we stay ahead of those curves depends which part of the valley train. You look out, so you see disruption in the banking industry really on two fronts. The first is you got this hope
operation of online lending platform? So these companies, which already cutting the uncouth and going straight to either consumers a corporate some offering them either better deal on credit or offering them credit in cases where the banks are not willing to step in, doesn't mean risk profile. He's been around another where it has been just been delivery of that sort of higher risk spending have been done through other mechanisms. Yes, that is in particular the EU is being intense competition. The landing side for many many years. I think the banks know how to deal with that. I think Whether is more concern as some of the innovation on the payment side. I think there's been a lot of frustration. Over the years as to. Why does it take so long to transfer money if I want to transfer hundred dollars. I send my bank and it takes two or three days for that show up with you. Why is that not instantaneous, and you are seeing
These new technologies allow you to send money instantaneously to people who do not bank, with the same by the banks, are looking at those technologies very close, lee- and I do think we have a very strong incentive to either adopt them- replicate them because there really the value proposition that now, but ending a maid banks have less money to people, consumers they ve. So I had credit card business is whether essentially financing again individuals and small businesses, a lot of people aiming at that space to, and sometimes with, the idea bring it cheaper or in a way that more familiar to a younger generation yeah
again. I think the way it's been delivered its new and some of the technology is definitely a lot better than what existed ten years ago, but that type a competition for a bank is something that they have had to contend with. For the last thirty or forty years. It's just the mechanism of delivery has changed. What's important. To keep in mind is that some of these companies are targeting borrowers that historically, have not being that attractive to the banking industry because they don't fit risk profile. So, what's interesting, is that you're starting to see some joint ventures between banks as some of these online lending platforms and again, I think the way the bank is looking at this when, when some of these funds, like you, do have better technology platforms, but we have access to a lot more clients than they do so why don't we embed their offering into the whole suite of things that we go out and offer Twa clients and if Rizzo client the wants to borrow money that doesn't meet our risk profile. But it me
one of the online lenders profile than everybody wins from that? So a lot of the media in the space you son, reasonably optimistic about the growth of consumer spending, which should be good for the banks and the ability of banks to capture on will be higher margins, as rates rise. When your big expectations for the industry in the EU, head and will on twenty sixteen be a year. Were investors in banks finally see some growth? I think the answer is, you will see growth in two thousand and sixteen, so just the mechanics of interest rates going up is going to add something between five to ten percent to the earning power of these banks. Second, we are starting to see long growth pick up after eight years of being very, very weak, which in turn, I think, will help to drive some growth in bank balance sheets and third, we are expecting that credit losses are going to remain
relatively low, just because unemployment is just so benign and we are expecting unemployment in the. U S will breach the five percent number on the way down. Unemployment, historically as being the single largest driver of, losing money on alone, portfolios that continuing to improve Richard. Thank you very much. Thank you. That concludes this episode of exchanges of gold. facts objects. You are, we hope you join us again. Next, this pot cast was recorded on December seventeenth, two thousand. Fifty all price references and market forecasts correspond to the date of this recording this pod cash should not be copied, distributed, published or reproduced in whole or in part. The information contained in this package does not constitute
search or recommendation from any Goldman Sachs Entity to the listener. Neither Goldman Sachs nor any of its affiliates makes any representation or warranty as to the accuracy or completeness of the statements or any information contained in this podcast. and any liability, therefore, including in respect of direct indirect or consequential loss or damage, is expressly disclaimed. The views expressed in this podcast are not necessarily those of Goldman Sachs and Goldman Sachs is not providing any financial, economic, legal, accounting or tax advice or recommendations in this podcast. In addition, the receipt of this podcast by any listener is not to be taken as constituting the giving of investment advice by Goldman Sachs too. That listener, nor to constitute such person a client of any Goldman Sachs Entity.
Transcript generated on 2021-10-15.