Financials: rising rates & digital opportunities

The tailwind of rising interest rates comes as technology-driven changes to traditional banking represent both a challenge and an opportunity for market players. The bank of tomorrow will be more digital, faster and cheaper, and will also require regulation to protect consumers who are chasing competitive pricing and convenience. Innovative incumbent banks are well-positioned for the future.

Key messages

• Rising rates are good for banks and other financials. If the Fed achieves “lift-off” in 2022, then expect the financial sector to continue to trade higher.
• Rates expectations are rising in Europe, the UK and Asia too, where banks and other financials also offer significant dividend yield opportunities.
• Against the positive rates backdrop, the banking industry is changing in response to demographic and technology trends, including new digital-only competitors. Innovative incumbent banks are meeting the challenge with their own digital initiatives.

Rising rates are good for US banks…

With the US Federal Reserve expected to start raising rates this year, US 10-year rates have jumped by 20bps in early January to ca. 1.74%. As a result, bank stocks have also been strong so far in 2022, as they stand to benefit from higher net interest income and margins.

If market rates can push above 2%, and the Fed starts to increase the Federal Funds Target Rate (FDTR) in line with the dot plot (+75bps in 2022), then we expect that US banks can continue to trade higher too.

The S&P 500 Banks index has already gained over 85% since US 10s bottomed at 0.5% in July 2020, yet valuations support further earnings-driven upside as the rate story develops.

…and for financials in Europe, the UK and Asia too

As economies recover, market rates are also trending higher in Europe and the UK, and in parts of Asia, providing a tailwind for both banks and insurers in those markets. Meanwhile dividend yields in European and Asian financials, in comparison to the US where they are just above 3%, are over 4% and as high as 7%.

Digital threat, or opportunity?

Against the positive interest rate backdrop, the banking industry continues to face new competition from digital-only neobanks that operate without the cost of legacy technology or physical branch networks. Neobank user growth accelerated during Covid; by total users, some of the largest are NuBank (Brazil), Revolut (UK), Kakaobank (Korea), Chime and Dave (both US). Incumbent banks are not waiting to be left behind Facing neobank competition, banks may match offerings (e.g. scrap overdraft fees), but more significantly the more innovative ones are evolving their businesses to meet the digital challenge, including:

• Goldman Sachs’ digital platform Marcus targets USD 125 bn worth of deposits and USD 20 bn in loans/cards by 2024, representing 29% and 150% growth respectively, compared to 2020.
• J.P. Morgan acquired UK digital wealth manager Nutmeg in 2021 to complement the launch of digital bank Chase in the UK.

Singapore case study: licensing helps incumbents

In 2020, the Monetary Authority of Singapore awarded 2 Digital Full Bank licenses to a Singapore Telecom/Grab Holdings consortium, and a wholly-owned entity of Sea Ltd, and two separate Digital Wholesale Bank licenses. New licensees were initially expected to commence operations from early 2022, but the licensing exercise has spurred the incumbents to invest in their own digital offerings.

Market leader DBS Group has long invested in digitisation on the basis that everything is digital. In 2021 they launched Partior, a blockchain-based payments, trade and settlement joint venture with J.P. Morgan and Temasek, and DBS Digital Exchange, a regulated platform to issue and trade digital tokens.

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