The pace and magnitude of change emanating from on by the increased deployment of new, largely tech-driven tools and regulatory easing lead to optimism among bank CEO’s these days. Banks are freer to focus on business opportunities more than they have been for some time. While the environment is far riskier than in past years due to highly volatile and unpredictable economic swings and policy making, the fundamentals of the US economy and the efficiency opportunities brought by AI are reaso0ns for excitement looking forward. The volatility brings with it not just unprecedented opportunities, but also the need to increase focus on adverse scenarios and plans to handle them.
An excellent example of unpredictable uncertainty is the Iran war, which could yield a variety of results ranging from a wave of prosperity and low oil prices to a global economic tightening and distress due to the inability to efficiently allocate energy sources around the world. Having reserves in place and sufficient capital to handle credit issues among your borrowers is always needed, and now is a good time to shore those up even further. The credit cycle downturn has been anticipated for many years now. We all know it’s inevitable; the real question is when. Now isn’t the time for complacency (is there ever such a time?) in your credit departments, though, and your own underwriting should reflect that even when the probability of default is increasing, large loss given default predictions still call for cautious underwriting and reserve allocation. Our industry’s credit losses have been below normal for many years and even as you underwrite to a higher level of losses. This is particularly true in vulnerable industries such as energy and unsecured consumer loans, including cards.
The unprecedented growth in private credit lending also raises concerns during volatile times. Some say credit underwriting in that sector and in leveraged lending has been shoddy. Now is the time to check your concentration risk in such sectors to ensure that, should it get into trouble, you won’t be swept along. It’s likely that these sectors will experience higher losses in the next downturn, and you should be prepared by managing both your expected yields for higher risk portfolios as well as what percent of capital and quarterly earnings are you willing to risk on this segment. We all know there is always one industry that gets hit particularly hard in a credit cycle. While we don’t know which industry will be hit next time, we can manage concentrations to ensure that a downturn might be painful but not lethal.
AI has been a hot topic in these past twelve months, and it’s getting hotter. This is especially true for our largest banks. Most of us, while we like the concept, find it hard to implement in our smaller environments that rely heavily on human experience both internally and externally. Consider AI in the context of the certainties of what will not change in the coming year and planning horizon: the basics of our business. We fund the needs of individuals and businesses and will continue doing so; all our customers will still need to save money, raise capital, invest excess liquidity, and so on. AI can help us provide these services more efficiently and timely to our customers And reduce the pressure on our own people to perform routine tasks for hours on end.
The driver behind the deployment of AI tools at most banks is about internal operational efficiency and reallocation of human resources to less mundane, more value-add tasks. That can continue to be your mantra. The largest banks are directing much of their AI investment toward improving the customer experience, which helps drive the company’s continued financial success. Jasmie Dimon does not believe the use of AI tools will result in improved efficiency and improve financial results at JP Morgan. While he agrees that effective use of AI tools will reduce operating costs overall, right now it is resulting in employee job-switching to higher-value-add positions. His goal is to improve the end-user experience, not to reduce costs.
We should all recognize that local and regional banks who personally know their customer bases have a unique competitive advantage. Our country’s largest banks can keep developing ever-improving CRM tools that know its customers, but they will never be able to compete with the local banker who asks about the family dog and your grandchildren. This is why I’m suggesting to invest in AI in the bank office for community banks. Our advantage is in our people, and we should lean into it. Our disadvantage is the cost to deliver our services, which is why AI should help us displace some of that cost. All banks make in AI tools can create strategic advantages, but the bank needs to embrace changes in their standard operating procedures to optimize those advantages. Automating the same inefficient process will not get you anywhere. A $10 billion bank can form the right fintech partnerships to provide the software tools, and, with the CEO’s commitment cascading throughout the organization, can become a strong competitor against much larger banks. Great technology can be the great equalizer, not simply a disadvantage relative to the larger banks with far deeper pockets. Future success depends on any organization’s leadership, strategic clarity, vision and the willingness to dream. Size helps, but doesn’t negate the many opportunities that exist at any bank reading these words.