Inflation’s Impact on Banking

Ashley Garrison: Hello, and welcome to this episode of Baker Hill’s Lending Made Easy. Today we’re going to be talking about fintech and financial stability. More specifically, we’ll discuss inflation and how it impacts banking. 

It’s all over the news. 

You see it in your gas prices at the pump, but let’s talk a little about this inflation impact in financial spaces and in terms of cash in deposits at banks and credit unions and what that means long-term for lending.

Bryan Peckinpaugh: Yeah, fintech and financial stability is a timely topic. As we were kicking this around at dinner last night about what this means to the financial institutions that we work with and serve, you know, one can argue that inflation, in general, is a net positive for the financial institutions. However, it depends on how you view them, either net creditor or net debtor.

What are your thoughts on what A: you’re seeing as it relates to just the numbers in the market, but B: how long do you think it’s going to be here and what the impact could be?

David Catalano: Right off the bat, mortgage rates are 30% higher than at the beginning of the year. You’ll see mortgage lending fall, which should impact, bank earnings.

You’ll also see impacts on housing—a house is the inverse of a bond, right? The value goes up when rates go down. The value is down when rates go up. The population of people that can afford the same house goes down, right? Supply and demand dynamics change. 

But, I think the bigger issue here is the compression of the yield curve. 

If you take the 10-year yield and subtract the two-year yield back in December, you get 80 basis points. Today you have six. 

We see the long end of that yield curve compressing, and what that tells us is that the bond market’s indicating that there’ll be a slowing in the economy and the rates will be reduced in the long term because of that slowing in the economy.

An inverted yield curve is not a good thing for banks because they borrow short-term and they lend long-term. If you’re borrowing circuits are creeping up on what you’re actually lending at, your margins are becoming compressed. 

The question here is what’s going on. When you combine that with what’s going on in the economy think about what happened: 

• April 2020: $1,200 went out in a stimulus check to consumers. 

• May–July 2020: We enhanced unemployment insurance. 

• January 2021: We cut $600 additional checks to everybody. 

• March 2021: We cut $1,400 checks to everybody. 

• July 2021: We increased the child tax credit. 

And this is the big one: government spending is $1.3 trillion less this year—2022—than it was last year in 2021. 

And that’s basically hitting year-to-date Q2. 

So all this money came into the system last year, starting in the year before and all last year. That’s not here this year. The amount of cash that consumers are going to have to spend in stores is going down. We’re going to have a rate of change, slow down. 

At the same time, we got 7.9%. And the Fed’s going to raise rates into a slowing economy. Traditionally, when that happens, you get a recession. You definitely have the economy slowing right now. You have commodity prices deflating and commodity prices going down.

So yeah, inflation is very, very high. 

To fight inflation you typically raise rates, but when you raise rates in an economy that’s slowing—and the slowness is because the stimulus has gone—that’s a huge problem. And that’s a bigger problem for banks because that’s going to impact spreads. 

It impacts commercial lending volumes, that impacts performances of portfolios across the board, but in particular consumer portfolios.

So to me, it doesn’t paint a great picture. Inflation is just one element of what I think is happening right now related to the world of fintech and financial stability.

Bryan Peckinpaugh: Yeah. A lot of it depends on if you look at the creditor or debtor aspect of this, right. I think you mentioned mortgage and we very well will see a trail off potentially of mortgage volumes and revenues associated with mortgages across the financial institutions. 

As housing prices go up at the same time as we were seeing all the other things you were talking about. But that can then potentially be offset by increases in other borrowing, because I do need additional funds to stay at the same level of maybe standard of living that I was at before, because my existing dollar doesn’t go as far. I need more of them.

So there may be increases in other aspects of the lending that financial institutions do. What it screams to me is the need for different types of technology or looking at existing technology in different ways where.

We’ve rode high in the fintech and financial stability industry over the last couple of decades on very low net charge-offs, very strong credit portfolios, very low-risk loans that were being made and an ability to slice and dice differently, both from an existing portfolio perspective, as well as making good sound go-forward credit decisions based on maybe exposure or risk in certain markets, evaluating my concentration in certain NAICS codes that might be more impacted by some of the supply and demand issues that we’re seeing. 

You were mentioning consumer in general, David. Even breaking that down further of what areas of the country are we serving and what we think is going to be hit harder than others, I see a turn towards a lot more use of analytics. Being intelligent about our fintech and financial stability data and lending workflows is going to be a much higher need in the coming couple of years, as we try to navigate our way through this.

Ashley Garrison: And, Brian, if I can jump in here, one of the things that I’ll say out loud, you know, if you’re a bank or a credit union, your numbers are all over the place after the last two years because of the pandemic, what do you do to get yourself back in line with what your data should look like?

“What’s a banker to do?” is what I’ll put out there.

Bryan Peckinpaugh: Yeah, great point, Ashley. I mean, David, you and I talk about the need for benchmarking. How do I know that 3% household growth is good in an upturn world? I can’t look at it and say, here are my numbers over the last three to five years, because they’re going to be completely different for 2020 and 2021.

Having some type of comparison across markets, across financial institutions, across segments is going to be critical in understanding where I stand. And am I good or bad? The numbers aren’t just the numbers anymore.

David Catalano: I would agree that when we see a compressed margin environment that’s a great time to evaluate process and potentially make investments in digital lending technology to make your teams more efficient. 

There’s a ton of efficiency to be gained, at least in the banks that I talk to all the time, where you’ve got disparate process and people re-entering data multiple times. It’s not creating a wow experience for clients. And, it surely creates a lot of extra work for the teams that are there. 

We know the teams are getting thin. It’s hard to replace workers that leave and workers that are overworked do want to leave. Right? They want to find a better greener pasture just because the work is tedious. 

That to me, screams of looking at a digital process, transforming the way in which we work that will enhance margins, enhance customer experiences.

The key to creating a wow experience for a customer is to make sure your employees experience “wow-ness” in their work and are treated really well because they’re never going to treat the customer any better than they’re treated and that includes the tools they have to use. 

So I think, when you get into an environment like this, it’s a great time to evaluate process. And evaluate your tech spend, where are you putting that? 

And if you’re a community bank, you’re likely making the majority of your income from commercial lending and what a great place to take a look at process and how are we treating customers? How are we dealing with the business customers that we know are facing headwinds, both on the employment side and potentially on the demand side, because these consumers don’t have the pocket full of cash that they used to. The rich do, but you know, the middle-class don’t. 

So I just think it’s a good time to evaluate those fintech and financial stability processes.

Bryan Peckinpaugh: I think we should also look into submitting “wow-ness” as word of the year for 2022. I don’t know how you go about doing that, but I think that’s a fantastic word to get added to the dictionary next year. 

Ashley Garrison: Well, awesome. I think with that “wow-ness,” we’re out of time for this episode of Baker Hill’s Lending Made Easy covering fintech and financial stability.

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