Banking regulation changes start new era

A shift to a balanced regulatory environment is underway after the 15-year period that followed the global financial crisis (GFC), in which shareholder returns took a back seat to ever-increasing capital requirements (given a punitive supervisory backdrop). These requirements negatively impacted industry profitability, competitiveness and stock valuations, but now the landscape has changed. High-performing banks should be on an improved footing to challenge bank and non-bank competitors (fintechs, private credit, Big Tech), aided by increasing management bandwidth, as the regulatory burden declines. This backdrop should also serve as a tailwind for industry consolidation, which is much needed in our view, given the fragmented nature of the U.S. banking market (approximately 4,000 banks) vs. other countries. We anticipate a series of rulemaking on capital and leverage requirements over the coming quarters that should provide banks with improved flexibility regarding capital allocation. As a result, the group is likely to be viewed as a viable investment alternative on secular growth themes, which should aid the valuation multiples that investors are willing to assign to bank stocks. Small- to mid-size regional bank valuations could benefit most from this expected pickup in M&A.

Crypto legislation is a top priority for the current administration, with legislation that should provide the necessary framework for banks (and non-banks) to participate in the digital assets-/blockchain-based innovation across financial assets. We view the increased adoption of digital assets, including stablecoins, as posing risks but also offering significant growth opportunities to the banks. Potential competitive risks for the banks stem from the emergence of an alternative for rate-sensitive deposits (similar to money market funds) or the entrance of Big Tech/Big Retail as stablecoin issuers (offering loyalty programs). However, we are likely in the early innings of this technological shift, as the need for a well-defined regulatory framework, interoperability (so that digital assets can seamlessly be used across systems) and a relatively smoothly functioning consumer payments ecosystem in the U.S. could slow down the pace of adoption.

We believe that the investor narrative around how the private credit industry grows at the expense of banks underestimates the strong value proposition offered by banks via their origination, distribution and funding capabilities. Outside of areas where banks choose not to compete aggressively (subsets of non-investment-grade, leveraged lending), so far there is limited evidence that banks have lost meaningful market share to private credit. We do view private credit as an asset class in secular growth mode and expect banks to participate, with the largest banks best positioned with their loan origination (investment banking, lending verticals) and distribution (wealth management) capabilities. An improving regulatory backdrop should also narrow the regulatory arbitrage, which has favored the non-banks, by improving the ability of the banks to compete in this space.