Focus on financials: Why banks and asset managers are constructive about the economy in 2024

Episode Summary

Executive Summary: Goldman Sachs’ financial services conference painted a more constructive macro outlook than a year ago: banks expect a soft landing, lower recession odds, stable deposits, and low unemployment/defaults even as rates stay higher for longer. The discussion centered on muted loan growth, rising competition from private credit, CRE stress concentrated in office, and major regulatory change under Basel 3 that could reshape bank lending, liquidity, and consolidation.

Main Topics: Macro outlook: soft landing over recession (Priority: 5/5): Banks at the conference turned notably more optimistic versus last year, cutting recession probabilities and expecting slower growth rather than a severe downturn. Key fears around additional Fed hikes have receded, and the focus is now on a manageable slowdown with labor and credit conditions remaining solid. Deposits, funding, and higher-for-longer rates (Priority: 5/5): Deposit flows have been unusually stable, helped by banks becoming more competitive on savings/CD rates and by the stickiness of operational cash. Competition for deposits has eased as loan demand remains weak, reducing the need for incremental funding. Weak loan growth and private credit displacement (Priority: 5/5): Loan growth is near zero outside of credit cards, reflecting tighter underwriting, more cautious bank balance sheets, higher capital requirements, and strong competition from non-bank lenders—especially private credit. Private credit expansion and asset manager opportunity (Priority: 4/5): Private credit has grown into a large, broadening asset class spanning sponsor lending, distressed, mezzanine, real estate, infrastructure, and asset-backed finance. Speakers see continued growth as institutions seek yield and as banks retreat from certain lending activities. Commercial real estate risk, especially office (Priority: 4/5): Banks are more comfortable with office reserves, but office remains the main CRE stress point because of oversupply and refinancing pressure. Multifamily was highlighted as more resilient due to strong rental demand and limited overbuilding. Basel 3 and regulatory pressure on banks (Priority: 5/5): The proposed Basel 3 framework could require large U.S. banks to hold substantially more capital, raising costs for loans, constraining market liquidity provision, and potentially driving higher lending prices and more bank consolidation. Liquidity, runs, and market structure after the regional bank crisis (Priority: 4/5): The spring bank turmoil reinforced how fast deposit runs can occur in the age of social media and mobile banking. Banks may need more liquidity, shorter-duration assets, and more diversified deposit bases, while regulators may try to limit leverage outside the banking system.

Key Arguments: Banks now see the economy’s base case as a soft landing, with recession risk materially lower than six to nine months ago. Interest-rate tail risks have diminished; most banks think the Fed has likely already done enough to bring inflation down. Deposit outflows have stabilized because banks raised deposit rates and because much of the remaining cash in the system is operational rather than yield-seeking. Loan demand is depressed because banks are tightening underwriting, preparing for higher capital needs, and losing share to private credit. Private credit is growing structurally, not cyclically, and is moving from an alternatives allocation toward a broader fixed-income role. Office CRE is the main credit problem; multifamily appears much healthier due to rent growth, strong housing affordability pressure, and less oversupply. Basel 3 could raise capital requirements enough to increase loan prices for consumers, small businesses, and certain sectors, while also reducing bank market-making and treasury-market liquidity. The March/April bank stress episode showed that depositor behavior now resembles creditor behavior and can accelerate rapidly via technology. Some liquidity and intermediation functions may migrate to non-bank actors, but those actors may not reliably provide backstop liquidity in stressed markets. Smaller banks may face strategic pressure to merge because higher regulatory costs could make scale essential for competitiveness.

Data Points: Probability of recession next year: Most banks have significantly reduced it - Conference takeaway on macro outlook Fed rate hike tail risk: Another 100 to 200 basis points seen as extremely unlikely - Banks’ revised view on where interest rates could end up Deposit flows stability: Remarkably stable over the last 3 to 4 months - Banking system funding trends Loan growth: Zero at the moment - Why banks have less need for incremental funding Credit card lending growth: Double digit - Only major loan category still growing rapidly Private credit AUM: About $2 trillion - Current size of the private credit market Private credit growth rate: About 20% CAGR over the last five years - Historical expansion of the asset class Private credit share of global fixed income AUM: 7% - Indicates room for further expansion Average institutional allocation to private credit: About 3% - Current allocation level cited at the conference Potential institutional allocation to private credit: As high as 10% - Some firms’ target allocation views Expected private credit growth: 20% to 25% per year for the next five years - Goldman Sachs view on future expansion Office CRE reserves at large banks: 8% to 12% against office loan exposure - Banks’ current expected loss coverage Office exposure loss expectation: 8 to 12 cents on the dollar - Interpretation of reserve levels Historical comparison for office losses: Comparable to 2008-2009 - Context for current reserve severity Basel 3 capital increase proposal: 15% to 30% more capital - Likely requirement for the largest U.S. banking institutions Capital vs. 2007 comparison: 2.5x more capital for the average U.S. bank - If the proposal were implemented FDIC deposit insurance limit: $250,000 - Threshold above which uninsured depositors are treated as unsecured creditors Money market fund inflows in 2023: Over $1 trillion - Illustrates cash moving out of bank deposits into higher-yielding instruments

Pivotal Quotes: "Most banks have significantly reduced their view around the probability of a recession for next year." — Richard Ramsden: Summarizing the conference’s macro tone "The banks are taking the view that the Fed has threaded the needle." — Richard Ramsden: Describing why a soft landing is now the base case "Credit is credit." — Alex Blostein: Acknowledging that private credit will still experience losses in a downturn even if its structure reduces systemic risk

Implications: Expect slower but resilient growth, continued pressure on bank lending margins, more private-credit displacement, and likely bank consolidation. Regulation may reshape capital markets liquidity and make bank financing more expensive across the economy.