Banks: Going Great Now, But…

This week’s bank earnings reports are expected to be strong, but finance leaders need to look ahead and anticipate future risks.

A jet stream of positive indicators is propelling Wall Street’s biggest banks ahead of earnings season. But bank leaders must still deal with the dreaded “r” word that shadows this industry.

According to most analysts, Citigroup, JPMorgan Chase, and Wells Fargo are all forecast to outperform expectations when they report their second-quarter earnings on Friday. And for good reason: A strong lending environment, combined with the fiscal fruits of tax reform and another passing grade on the most recent stress tests, is more than offsetting the impact of a trade war in investors’ eyes. Add an increasingly favorable regulatory environment to the mix and conditions haven’t been this good for banks in years.

But in the eyes of many industry watchers, this combination of factors makes it all the more important that bank leaders carefully manage short-term risk. “With high lending volumes and a relaxed regulatory environment, underwriting tends to relax as well,” says Eric Pikus, head of global financial services in North America for Korn Ferry. “Leaders need to ensure that they are hiring the best risk and underwriting talent that will adhere to the most prudent standards as loan growth continues.”

Commercial and industrial lending is growing, and many areas of consumer lending—with the notable exception of mortgage loans—are rapidly expanding. Lending operations are becoming a more important component of earnings, “with many banks blitzing the market with aggressive hiring plans at mid-tier executive levels,” says Pikus. That makes identifying and developing talent in the area of lending more important than ever for banks. Says Pikus: “With the likely exodus of senior-level talent from the baby boomer generation, banks are faced with taking chances on the next-level talent. Leaders will need to stretch to bridge experience gaps like never before. There will be greater organizational risks.”

Banks stocks had been taking a beating for most of this year, with the financial sector negative for the year and rated as S&P 500’s second-worst-performing sector over the last three months. But after a strong showing during the Federal Reserve’s stress tests in late June, where all but four banks were found to have enough assets and capital on hand to withstand a financial crisis or global recession, they have experienced an uptick. Analysts expect some banks to increase share buybacks and dividends with surplus capital from the stress test results and tax reform; one estimate says the six largest US banks could increase their returns by about $80 billion combined as a result of passing the most recent stress test.

Still, the volatile political environment and an escalating trade war with China—the United States on Tuesday announced an additional $200 billion in Chinese goods being considered for tariffs in addition to those already imposed—can spoil the outlook in immediate, unforeseen ways. That uncertainty, in addition to fluctuating investment banking and trading revenues and lagging mortgage banking due to rising interest rates, can heighten the stakes for those parts of the operation that are thriving, such as lending. Pikus says that the sector is so far appropriately focused on expense control. As the pressure on more traditional banking areas increases, rigid risk control must continue. It’s up to financial-sector leaders to ensure that it will by hiring the best risk management talent they can find.