While S&P Global Ratings expects banks' capital markets revenue to be flat to up 10% in 2024, we also think there will be some rotation this year in terms of which parts of the capital markets business will drive performance.

In any given year, capital markets revenue is highly correlated to macroeconomic factors and market volatility, including movement in interest rates. But the strength or weakness of each of the underlying components of capital markets activity--trading, underwriting, and advisory--will likely diverge depending on market conditions. For example, when there's an expectation of a major shift higher in interest rates--as was the case over the last two years--revenue from fixed income, currencies, and commodities (FICC) trading would likely be strong, as clients look to reposition their portfolios. However, these same dynamics would make conditions tough for advisory and debt underwriting, because of economic uncertainty and because of reduced debt issuance amid widening credit spreads.

Right now, more than four months into 2024, the global economy seems steadier than it was last year--but a good deal of uncertainty remains. Interest rates seem to have peaked, but the likelihood and extent of the rate cuts that many expected at the start of the year have been dwindling, with inflation proving tough to tame. A soft landing for the economy seems more likely now than it did last year, but it's far from a certainty. And rising geopolitical tensions, along with continued armed conflicts, have added a further layer of uncertainty.

Still, we have a more favorable outlook for the economy this year; that should bolster debt and equity underwriting, and it could possibly act as a fulcrum for merger and acquisition (M&A) activity. But lower volatility and tough comparisons to last year will likely be headwinds for trading revenue, particularly for FICC (see chart 1).

Chart 1

Positively, the banking system, after several noteworthy bank failures last year, seems to be on more solid footing. Much of the focus has turned to the extent of banks' exposure to U.S. commercial real estate. In addition, increasing deposit rates will likely hurt net interest margins this year; this, in turn--along with the sluggish loan growth that we expect--will likely pressure net interest income.

Given this headwind, capital markets revenue will be an important factor in determining the strength of banks' earnings this year, mainly for the large banks that are active in investment banking and trading. In the U.S., we expect the banking industry to generate a return on equity of about 10%, down from 11% last year. Our expectation for European banks is marginally below this level, but it's still supportive of our ratings.

From a ratings standpoint, a bank's capital markets revenue is more volatile and difficult to predict, in our view, and it often carries greater risks than its lending activity. However, when capital markets activity is done in a prudent manner, and if it's not outsize in terms of a bank's revenue stream, revenue derived from the capital markets can complement that bank's business model. At the same time, an overreliance on capital markets revenue can weigh on bank ratings.

Among the banks where capital markets revenue contributes a meaningful amount to total revenue is Barclays PLC, which we upgraded in May 2023 by one notch, to BBB+/Stable/A-2; there were similar upgrades for its core operating subsidiaries. This reflected the bank's business diversification and strengthened performance.

Last December, we raised both the long-term and short-term issuer credit ratings on Deutsche Bank AG by one notch, to A/Stable/A-1. This reflected the bank's strengthened performance and resilience, as well as its disciplined strategic execution.

And earlier this month, we revised the rating outlook on JPMorgan Chase & Co. (A-/Positive/A-2) to positive from stable, reflecting, among other things, the bank's ability to deliver solid results in varied economic conditions, helped by its strong capital markets franchise.

(For a list of ratings on all of the banks we cover in this commentary, see the Appendix.)

Our Projections For Banks' Capital Markets Revenue In 2024

For the banks we cover in this commentary that have a December year-end reporting date (thus excluding Nomura Holdings Inc.), capital markets revenue declined by 5% in 2023--in line with last year's forecast of flat to down 10% (see chart 2).

• Advisory (revenue down 20%) was the category that posted the largest revenue decline last year, as economic uncertainty and high interest rates slowed down deal volume.
• FICC and equity sales and trading revenue were down by mid-single digits, largely because of tough comparisons.
• Equity underwriting was the only category to show significant year-over-year revenue growth (25%), supported by a sharp rise in the value of equity markets and by rather easy year-over-year comparisons. (Debt underwriting was up modestly.)
• Still, both equity and debt underwriting revenue fell short of pre-pandemic (2019) levels. Advisory revenue was essentially flat relative to where it was in 2019, while FICC and equity trading revenue were well above that year's levels.

Chart 2

Our expectation for capital markets revenue in 2024--that it will be flat to up 10% from last year--accounts for our view that different categories of capital markets activity will drive this year's results.

• We project that FICC trading revenue will still be relatively strong--just not as strong as in 2023. Specifically, absent any significant surprise moves in rates, client volume will likely decline since there will be less of a need to reposition their portfolios. That said, asymmetric timing of rate cuts across regions could spur activity.
• Equity trading revenue should be strong because of client needs to reposition in the equity markets and because of elevated prime brokerage activity.
• And lower rates (should they occur), combined with a more sanguine economic outlook and a continuation of attractive equity market valuations, should bolster debt and equity underwriting revenue, as well as advisory revenue.

First-quarter results for U.S. banks that are active in the capital markets support our projections. For the largest players combined, capital markets revenue was up 4%, with debt and equity underwriting showing the strongest results. But the first quarter is typically the strongest quarter of the year for capital markets revenue, and there's concern that some of the activity, particularly in debt underwriting, was pulled forward as borrowers took advantage of attractive credit spreads. Indeed, looming over all capital markets activity are geopolitical risks, the ongoing armed conflicts in two regions of the world, the upcoming U.S. presidential election, and the uncertainty and volatility they all could bring to the markets.

In addition, continued high interest rates could hamper investment banking results since companies may pull back from acquisitions and planned issuances.

Key Themes In The Capital Markets Business In 2024

The dynamics of advisory revenue

The strength of banks' capital markets revenue in 2024 will depend in part on whether advisory revenue can rebound from a dismal 2023. Aggressive rate hikes last year changed the dynamics around what acquirers are willing to pay for a company. Higher rates made debt financing more expensive, especially for non-investment-grade companies. The inability of buyers and sellers to agree on the value of a company, combined with an uncertain economic outlook, slowed down deal volume.

Although announced M&A volume was down at the end of 2023, earnings results suggest it picked up in the first quarter. This should translate into higher advisory revenue down the road, likely in the second half of 2024. But whether this momentum can be maintained likely hinges on whether rate cut expectations become a reality--higher-for-longer interest rates could slow M&A activity once again. Positively, though, there is a lot of pent-up demand.

The competitive threat from private credit

In recent years, private credit--made up in part by leveraged loans that are negotiated directly between lender and borrower and are not traded in the market--has been competing against banks' syndicated loan activity. Borrowers may choose private credit over a syndicated loan for the tailored terms and the speed and certainty of execution that private lenders can offer. Syndicated loans may carry lower rates, but they may also be less flexible in their terms. It's still unclear the extent to which private credit will compete with banks; issuance data for the first quarter of 2024 showed a swing back of some leveraged loans to banks from private credit.

Recognizing the potential competitive threat, the largest banks have mounted a response. The banks that have asset management arms have added private credit funds to their offerings, looking to earn management fees to offset any losses in underwriting revenue. Some banks have been putting aside capital to fund on-balance-sheet private lending offerings, at times teaming up with private equity firms; by doing so, they look to offer their clients a suite of solutions to their funding needs.

Headwinds upon Basel III finalization

Regulators around the world have weighed in on how they'll implement the final Basel III capital standards. Japan and Canada were the earliest adopters, and it's scheduled to go live in the EU and U.K. in 2025. The U.S. start date is yet to be determined. A proposal was put forth last year, but regulators have since indicated that the proposal could change materially when the final rule is issued.

One component of the final Basel III standards that will affect banks' trading activity stems from the Fundamental Review of the Trading Book (FRTB), which will result in higher minimum capital requirements for trading activity. FRTB uses expected shortfall, as opposed to value at risk, as a measure of risk under stress in an attempt to better capture tail-risk events. As a result, banks will be required to use a significantly more complex and risk-sensitive calculation than in the past to measure risk-weighted assets. Given the complexity and the more difficult approval process for internal models, some banks may opt to use a standardized approach to calculate market risk for all of their trading portfolio (or at least a portion of it, which, in turn, would pressure market risk weights).

Ultimately, the final Basel III standards will likely increase banks' risk-weighted assets for market risk, though banks should be able to mitigate part of this. As a result, this could impact the pricing of capital markets activity and the amount of trading assets banks are willing to hold on their balance sheets. (For more details, see "EU Banking Package: Inconsistencies Temper Framework Improvements," published Jan. 9, 2024, and "Credit FAQ: How The U.S. Proposes To Implement Basel III Capital Rules And The Impact On U.S. Bank Capital Ratios," published Jan. 11, 2024.)

Individual Banks' Capital Markets Performance

Market share

While there was little change in the ordering of capital markets revenue market share in 2023, JPMorgan Chase, Bank of America Corp., and Citigroup Inc. did pick up market share (see chart 3). European banks overall, having picked up some market share in 2022, moderately increased market share in 2023; Barclays, though, lost market share after a strong 2022. (We calculate market share by dividing each bank's capital markets revenue by the sum of the capital markets revenue of rated banks that are significant players in this area.)

In addition, Barclays recently announced that it will cap the share of regulatory risk-weighted assets devoted to its investment-banking arm in favor of other businesses. Specifically, the bank intends to hold investment bank risk-weighted assets steady as it targets growth in retail and corporate banking, private banking, and wealth management. That said, the bank will continue to focus on the capital markets business, and it will remain the bank's largest business segment, with about 50% of total risk-weighted assets.

Chart 3

Capital markets revenue as a percentage of total revenue

In 2023, banks' capital markets revenue fell as a percentage of their total revenue; the median percentage among the largest banks was 30% last year, down from 32% in 2022 (see chart 4). This was largely a result of higher net interest income, driven by the high rate environment.

But this year, we expect net interest income to decline, which will likely result in capital markets revenue rising as a percentage of banks' total revenue.

Chart 4

Breakdown of capital markets revenue by bank

According to financial data company Dealogic, JPMorgan, The Goldman Sachs Group Inc., Bank of America, and Morgan Stanley are the revenue leaders in global investment banking--a part of the capital markets business that we think will bolster capital markets revenue in 2024. (For a breakdown of the components of 2023 capital markets activity at the banks that provide this data, see chart 5.)

Chart 5

Capital markets performance in 2023, by bank

Capital markets revenue declined at most banks in 2023--but to varying degrees (see chart 6). Bank of America was the only bank to increase capital markets revenue; higher revenue in its FICC business fueled the increase in rates, and it was also helped by an improved trading environment for credit and mortgage products (segments it focuses on) as well as an increase in secured financing activity. Meanwhile, Barclays experienced the largest decline in capital markets revenue, reflecting its emphasis on FICC and debt underwriting as well as its robust 2022 performance.

Chart 6

Volatility of capital markets revenue

Banks with simpler, more diverse capital markets businesses will likely generate capital markets revenue that is more stable (that is, with less year-to-year volatility) despite changing market conditions. Banks that focus largely on clients within their own lending base should also post steadier capital markets revenue. Bank of America and UBS Group AG are the banks that have seen the least volatility in capital markets revenue in recent years (see chart 7).

Chart 7

Risks

We believe banks' capital markets businesses are more opaque than traditional lending businesses, and the risks are more difficult to quantify. We look at various risk metrics within banks' trading businesses to gauge whether risks are elevated, but our lens to determine the risks of these businesses versus traditional lending business is more limited. Below we discuss two of the components of the trading risk metrics we monitor.

The level of market risk

One of the components of risk-weighted assets--the denominator in a bank's capital ratio calculation--is market risk. Market risk is the risk of loss in the value of inventory, investments, loans, and other financial assets and liabilities accounted for at fair value due to changes in market conditions.

Market risk rose in 2023 for roughly half of the banks covered in this commentary, and it decreased for the others. At the banks that saw market risk rise, the primary causes of the increase were an increase in stress value at risk (SVaR) and the use of more standardized risk weights for a larger portion of their trading assets. A rise in SVaR could indicate that a bank is holding a different composition of trading assets that could be riskier; it also could reflect a bank holding a higher amount of trading assets versus the previous year.

Chart 8

The level of market risk-weighted assets relative to trading assets

Another way to assess whether banks are holding riskier trading assets is to divide the amount of market risk-weighted assets posted in a quarter by the amount of trading assets at the end of that quarter. A low level of market risk-weighted assets relative to trading assets would indicate that the bank's trading activity is lower risk. An increase in this ratio could indicate a riskier trading book.

The results of this analysis for year-end 2023 are largely mixed, with market risk as a percentage of trading assets falling for some banks and rising for others. (Note: Trading assets and market risk in the chart below are as of year-end.)

Appendix

Related Research

• Research Update: JPMorgan Chase Outlook Revised To Positive On Franchise Strength And Ability To Deliver Solid Results; Ratings Affirmed, April 1, 2024
• Credit FAQ: How The U.S. Proposes To Implement Basel III Capital Rules And The Impact On U.S. Bank Capital Ratios, Jan. 11, 2024
• EU Banking Package: Inconsistencies Temper Framework Improvements, Jan. 9, 2024
• Research Update: Deutsche Bank Issuer Credit Ratings Raised To 'A/A-1' On Strengthening Performance And Resilience; Outlook Stable, Dec. 8, 2023
• Research Update: Barclays PLC Upgraded To 'BBB+' On Business Diversification And Resilient Performance; Outlook Stable, May 19, 2023
• Banks' Capital Markets Revenue May Feel The Strain Of Economic And Industry Uncertainty In 2023, April 13, 2023
• After A Big Year, Banks' Capital Markets Revenue Will Likely Fall In 2022, April 12, 2022
• Capital Markets Revenue Should Remain Robust For Global Banks In 2021 Despite Risks, April 8, 2021