As 2015 comes to an end, The Banker has brought together a group of high-profile experts in the world of finance and economic research to predict what will happen in the next 12 months. Silvia Pavoni asks them to share their views on the global economy and on what factors will shape banking in the future. 

Participants:

Roberto Setubal, CEO, Itaú Unibanco

Mike Rees, deputy CEO, Standard Chartered

Janet Henry, global chief economist, HSBC

Erika Najarian, head of US banks equity research, Bank of America Merrill Lynch

Erik Nielsen, global chief economist, UniCredit

The term ‘new mediocre’ has become a popular shorthand to describe the chronic state of flat economic growth and the limited future prospects that most countries around the globe are facing. Indeed, global economic growth is projected to be 3.1% for 2015, according to the International Monetary Fund (IMF), marginally lower than in 2014, with a gradual pick-up in developed countries and a slowdown in emerging ones.

The IMF expects the global growth rate to improve in 2016, but warns about the dangers of protracted sub-par growth. The panel of experts surveyed by The Banker share the same concerns, although they also highlight a few bright spots that may emerge from the otherwise lacklustre picture. Here are their thoughts on the economic outlook, as well as on key issues such as regulation and technology.

The Banker: Will the ‘new mediocre’ of economic growth continue to rule global markets in 2016? Which are the most worrying and the most promising economies in the world – both among developed and emerging markets – and why?

Mike Rees: I do think global growth will continue its current trend into 2016. The world is still recovering from the global financial crisis and we have yet to fully wean ourselves off the ‘drugs’ of quantitative easing [QE] and stimulus packages. We are seeing a correction in commodities, with both winners and losers, and while it is cyclical, there will be structural impacts, including reduced investment going forward.

However, global growth rates hide a very mixed picture. While growth in developed economies will remain relatively sluggish, growth rates in emerging markets will continue to be relatively attractive. Despite concerns of a slowdown, there is still good scope for growth in the medium term. If we then factor in some of the macro trends we are seeing, such as increasing urbanisation, demographic tailwinds and shifts to more consumption-led economies, markets such as Africa and south Asia will bring significant opportunities in the longer term.

The markets I worry most about are in the Middle East. Given the geopolitical uncertainty and low oil prices, it is difficult to see how things will play out in the short to medium term.

Janet Henry: The global economy is still in something of a muddle-through environment of weak nominal global growth requiring continued loose policy from the major central banks to address the ever lower inflation. While we expect the sharp slump in China's imports to start to abate soon, China’s gradual transition away from investment-led to consumer-driven growth means it is unlikely to have such a dramatic impact on global commodity demand, or world trade growth more broadly, as it did in the post-crisis years.

In 2016, the weakest economies will continue to be commodity producers in the emerging world, notably Russia and Brazil, which we expect to contract further. South Africa also remains a worry spot. Even commodity-consuming Turkey is likely to continue to disappoint.

Developed world consumers continue to fare better, supported by improving labour markets and an oil-induced boost to real wages, though investment spending growth appears set to remain lacklustre and the strength of the US dollar is contributing to a drag from net trade in the US. The eurozone’s steady, if unspectacular, recovery is set to continue, supported by consumer and government spending.

[The eurozone's] gross domestic product [GDP] growth forecast of 1.4% in 2016  is still slightly above potential – just not enough to make inroads into the huge amounts of labour market slack in the economy or to erode large debt burdens. And, with inflation set to continue undershooting, we expect European Central Bank QE to continue beyond September, against a backdrop where the the US Federal Reserve is finally raising rates very gradually.

Roberto Setubal: Economic growth will likely continue at a moderate level next year. We forecast that the world's GDP will increase by 3.1% this year and by 3.3% in 2016. We note that this forecast for 2016 is in line with the 3.4% average seen between 2012 and 2014. But we don’t see factors that could push growth higher than that – developed countries are already having difficulties growing at current rates, China will continue to slow down, and other emerging markets still need to find a growth model that relies less on commodities.

China will continue to pose the main risk to the global economy in 2016, as it still has to rebalance its economy amid high debt levels in the corporate and local government sectors. India is one bright spot among emerging markets, and could record growth of more than 7% for a few years. But China will remain the most important economy to the world – India’s contribution to world growth will remain about 50% of China’s contribution until the end of the decade. Brazil will have weak economic growth in 2016.

Erik Nielsen: Mediocre global growth will continue in 2016, but it is important to note the distinct differences between different regions: the US will continue to grow at about trend, Europe will continue to grow a bit above trend, while emerging markets are adjusting down to a new growth rate environment well below the happy years leading up to the crisis. I worry mostly about some of the bigger emerging markets, which are being hit by lower commodity prices and a troublesome policy response. Brazil, Russia and South Africa come to mind. 

The countries most likely to surprise on the upside – relative to expectations – are several of the eurozone peripheral countries, including Italy and Spain, as well as Germany, which is both weathering the slowdown in China very well, while creating jobs for immigrants at an amazing pace.

The Banker: Regulation and technology are reshaping banks’ expansion strategies and business models. Which elements of either regulation or financial innovation will have the strongest impact on banking next year, and why?

Mr Rees: Regulation can be a double-edged sword. On the one hand, banks have historically been undercapitalised and needed larger capital buffers to be able to withstand financial shocks. On the other hand, economic growth depends on not being over regulated, so this is an important balance to achieve. In developed markets, we have seen a plethora of regulation, including Basel III, Dodd-Frank, Fatca [the Foreign Account Tax Compliance Act], Article 55, Volcker and EMIR [European Market Infrastructure Regulation] to name just a few. As a result, across financial services, banks are changing their business models, reducing risk-weighted assets [RWAs] and rebalancing away from balance sheet heavy businesses towards capital-lite areas, such as private banking and wealth. This trend is set to continue.

However, in some emerging markets, notably China, we are seeing a liberalisation of markets, which is very exciting. Increasing renminbi usage and its potential inclusion in the special drawing rightsbasket [the international reserve asset created by the IMF whose value is currently based on the dollar, pound, euro and yen] represent a real growth area for those that can leverage the opportunity. 

From a technology perspective, a number of banks have had legacy issues, but it is not enough to simply rectify past issues. Financial innovation is essential if we are to capture the opportunities around digitisation. These are early days but there are a number of areas that banks are exploring, for example, using blockchain [the technology behind Bitcoin] in trade finance and the impact of 3D printing on physical supply chains.

So, while both will have an impact on banking, I think regulation will have the stronger impact in 2016 but the disruptive effects of technology won’t be too far behind.

Erika Najarian: On regulation, the good news is that the industry’s visibility on regulation continues to improve. With the exception of the net stable funding ratio, we have a good sense of how the US regulators are thinking through the alphabet soup of prudential rules. For larger banks, we think the comprehensive capital analysis and review [CCAR] will continue to have the strongest impact, as many banks with more than $50bn in assets call the stress test their ultimate binding constraint. I think strategic decisions will be bound by CCAR constraints.

Another piece of regulation that we think will have a big impact is the LCR, or liquidity coverage ratio. For decades, the rule of thumb in bank investing has always been to buy the stocks of potential sellers. We think that still holds, but we think what’s different this time around is that regulation has changed the dynamics of mergers and acquisitions.

In the past, potential acquirers could cherry-pick parts of the seller's balance sheet. Deposits are still valuable, especially in a rising rate environment, but deposits and all target liabilities must now go through a different analysis. If the buyer is a bank with more than $50bn in assets, the buying bank must now hold some amount of high-quality liquid assets against the acquired liabilities. This is different from just blowing out the leverage at the selling bank, which happened in the past. And not all liabilities are created equal. The LCR very much values low-outflow deposits, such as retail checking, very highly. So, more than before, we think a bank with a sizeable retail checking deposit component is even more attractive. Conversely, in theory, a bank with more commercial deposits that are non-operational may be valued at less, even if it has excess deposits relative to their loan size, given that an acquiring bank has to hold more low-yielding HQLA on balance sheet.

As for financial innovation, banks need to look at what I call ‘defensive’ financial innovation – such as mobile banking – and think about how to innovate ‘offensively’ without compromising risk. For example, can banks learn from the financial technology start-ups, and learn how the customer wants to interact with the industry, without sacrificing balance sheet risk and client security? Also, is there technology that can help eliminate manual back-office costs that are feasible to adapt, such as distributed ledgers?

I’m not sure if 2016 will be a ‘leap year’ for innovation, but the most successful banks are continuously thinking of pushing the innovation envelope, again, without sacrificing risk.

Mr Nielsen: TLAC [the total loss-absorbing capacity proposed by the Financial Stability Board]. The banking industry has been hammered by a tsunami of additional capital requirements and regulatory changes in recent years, and as the industry is adjusting, including via massive lay-offs, TLAC is now about to add another burden on the industry's balance sheets and capital structure.

Mr Setubal: Regulation is reshaping banks’ strategy, capital-intense activities are being reformulated or discontinued, and banks will have to balance capital-intense activities, such as loans, with capital-lite activities such as services, asset management, payments and so on. This is a big change for traditional banks. On the technology front, clients are demanding digital relationships. This also will require banks to invest heavily in technology to change the business model. Banks that are not investing in this direction today certainly will be behind the curve very soon.

The Banker: What are the most underestimated issues that banks ought to pay greater attention to as they enter 2016? And what are the most overestimated – and distracting – ones?

Mr Rees: I’m not sure banks have given enough thought to what the world will look like after QE and the stimulus packages have been withdrawn. Liquidity will be much tighter and we may see this starting to come into effect more next year.

Banks also need to pay more attention to non-traditional challengers. The likes of online peer-to-peer lending platforms and the Alibabas of this world are giving consumers viable and cheaper alternatives. They are less regulated, lower cost and nimbler than traditional financial institutions, and banks need to innovate or collaborate to keep pace with this new breed of competitor.  

I would argue that the impact on the global economy of the slowdown in China has been somewhat overestimated. While there are undoubtedly issues that China needs to address through its programme of reforms, a slowdown in growth is a natural part of the adjustment process, as China shifts to a new economic model – away from a manufacturing focus and towards a more service and consumption-led economy. Despite the slowdown, the increasing economic contribution of the more labour-intensive service sector means the Chinese labour market remains strong.

So while we should keep a watchful eye on the scale and pace of reforms, we should also keep things in perspective. The long-term China story is a more positive one than some would have us believe.

Ms Najarian: I don’t know if this is underestimated by large banks, but I think the industry may be surprised at how quickly retail deposits may re-price in a rising rate environment, given that new post-crisis regulation has placed more value on these types of deposits.

The most underestimated [issue]: while the banking industry needs to constantly push itself to innovate, I think it is distracting to think of financial technology credit providers as major competitors to banks. I don’t think those credit providers and banks – especially CCAR banks – operate in the same credit risk box.

Mr Setubal: Financial disintermediation is happening in different places at distinct paces. In this context, technology plays an important role, since it is a powerful enabler. The regulatory aspect is also something to pay attention to. I don’t see any issues that banks are overestimating.

Mr Nielsen: TLAC is the most under-estimated burden for European banks along with the negative rates environment.

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