These institutions, including heavyweights like Bank of America, JPMorgan Chase and Citigroup, have historically benefited from the spread between what they pay out in interest on deposits and what they earn from interest charged on loans and other income-generating assets. This spread, known as net interest income (NII), has played a crucial role in boosting their profitability over the past 18 months.

The dynamics of NII are closely tied to the actions of the Federal Reserve. As the Fed has continuously increased benchmark interest rates, these banks have followed suit by charging higher interest rates on loans, which includes everything from corporate loans to mortgages. However, in a somewhat paradoxical twist, they have not significantly increased the interest rates offered to savers, such as those holding certificates of deposit and savings accounts. This asymmetrical approach allowed banks to amplify their profit margins, at least in the short term.

Recent data from the Federal Reserve, however, paints a different picture. While consumer borrowing, especially through credit cards, continues to grow, it is doing so at a notably moderate pace. Corporate borrowing, on the other hand, has seen a decline over the past six months. Analysts accredit this shift to the impact of the rising interest rate environment. This slowing growth in lending represents a critical challenge for these financial giants, as it directly affects their NII, which has been a key driver of their profitability.

Morgan Stanley’s banking analyst, Betsy Graseck, highlighted the gravity of the situation in a note to clients, stating, “Loan growth has slowed dramatically. Our view is weak loan growth reduces NII growth into 2024.” This way of thinking is echoed by analysts at Morgan Stanley, who point out that the 25 largest US banks have seen loan growth slow considerably, dropping to approximately 1.5% compared to the previous year when it was tracking at an impressive 8%.

Another factor adding difficulty to the equation is the banks’ cautious approach to lending. They are anticipating new regulatory requirements, known as Basel III Endgame, which would necessitate them to hold a larger amount of loss-absorbing capital against their assets. To prepare for these changes, JPMorgan, for instance, has accelerated the process of securitizing a large portion of its loan portfolio.

Analysts anticipate that the upcoming earnings calls of these banks will be marked by discussions about Basel III Endgame, its expected impact, and the strategies banks plan to employ to alleviate the anticipated increase in risk-weighted assets.

JPMorgan, Citigroup, Wells Fargo, and Bank of America are the first among the largest US banks by assets to report their third-quarter results, with earnings disclosures scheduled for October 13 and October 17, respectively. Goldman Sachs and Morgan Stanley, whose businesses are more focused on trading, investment banking and asset management, will report their results shortly afterward.

In addition to the challenges presented by regulatory changes and slowing lending growth, banks are also facing pressure to offer customers higher savings rates to keep their deposits. During the pandemic, large banks like JPMorgan and Bank of America collected record levels of deposits. However, over the past 18 months, as the Federal Reserve increased interest rates, these deposits began to decrease. This trend was additionally aggravated by the fact that while these banks elevated their lending rates, they did not pass on the higher rates to their depositors, resulting in what is known as low “deposit betas.”

Recent data from the Investment Company Institute demonstrates that money market funds, which as of current offer yields upwards of 5% for investors, have attracted substantial inflows, bringing the total industry assets to $5.7 trillion. As the consensus strengthens around the Federal Reserve’s intention to maintain higher interest rates for an extended period, analysts expect banks to slowly increase savings rates to retain their deposits.

The culmination of these factors has put  pressure on bank stocks, which have lagged behind the broader market. Investors an analysts are closely watching the performance of bank stocks, especially in the context of the next few quarters. There are concerns about how banks will navigate the path of capital in a high-rate environment, how deposit behaviors are expected to change over time, the impact on funding costs, and the potential for an uptick in loan losses. While consumers have been steadily drawing down the savings they accumulated during the pandemic, analysts anticipate that, at some point, even financially strong consumers may feel the strain of higher interest rates, leading to increased loan losses.

In the field of investment banking, experts are predicting a decrease in earnings for prominent establishments such as JPMorgan, Goldman Sachs, Bank of America, Morgan Stanley, and Citigroup, with an approximate 4% decline anticipated in the third quarter. However, there is a glimmer of optimism as commercial activity seems to be rebounding after an extended period of inactivity, and there are even forecasts indicating that Goldman Sachs could potentially witness a year-over-year growth in investment banking fees, which would be the first occurrence of its kind since late 2021.

In contrast, fixed income and equity trading revenues are anticipated to have fallen by an average of 5% at these five banks during the quarter. Goldman Sachs is expected to have experienced the most abrupt drop, with analysts forecasting a 15% decline in trading revenue compared to the previous year, when it benefited from volatile markets due to central banks’ actions in raising interest rates.

In summary, the intersection of factors involving increasing interest rates, changing regulatory demands, evolving lending strategies, and the competition for deposits is introducing considerable difficulties and unknowns for major U.S. banks, ultimately influencing the landscape of their financial results and profitability.