There will be gains amid the strains. Despite wars, simmering trade tensions between the world's two largest economies, and likely big policy shifts with the incoming Trump administration, banks' creditworthiness should be steady in the year ahead. S&P Global Ratings believes that stabilizing economies, amid a well-managed reduction in inflation, will support banks' performance.

Geopolitical factors remain key risks. The effects of the Russia-Ukraine war, the Middle East conflict, and a potentially substantial increase in trade tariffs by the U.S. could have implications for the global economy and banks. In addition, large property sectors remain pressured, particularly the U.S. office market and residential sales in China. Real estate stress poses challenges especially to U.S. regional banks and the smaller Chinese lenders.

A third set of risks relates to global leverage. Still-high interest rates continue to squeeze weak corporates and households, contributing to credit losses and difficult funding conditions for banks. Under our base case, we expect credit losses for global banks to increase by 7% in 2025 and 8% in 2026.

Finally, some evolving risks surrounding cyber security, generative AI, and climate change may test banks' business models and risk management.

And yet, we see bright spots for lenders, particularly as the global economy looks set to pull off a soft landing from a period of high interest rates and steep inflation. The recent publication of our "Global Banks Outlook 2025" (on Nov. 14, 2024, on RatingsDirect) was followed by two webinars in which the banking team addressed wide-ranging questions from investors around the world. A large majority of attendees were neutral to somewhat positive about banks' prospects globally in 2025 (see chart 1).

The webinars gave us a chance to bring an international perspective to bank issues. We present an edited version of some queries asked at the two events.

A recording of the Asia-Pacific/EMEA webinar is available here. A recording of the Americas/EMEA session is available here. A video recap of our main points is available here. Our Global Banks 2025 Interactive Dashboard is here.

Table 1

Key Questions

How will falling interest rates affect banks in Western Europe in 2025?

Elena Iparraguirre:  We expect a somewhat more supportive macroeconomic environment next year. Economies will recover some dynamism on the back of rising consumer spending and an improved environment for investment. Inflation levels should continue to fall, leaving more room for central banks to cut rates, in our view.

The lower rates will support greater bank lending, and we are already seeing stronger demand. This pickup will ease pressure on banks' asset quality, which has proven quite resilient in recent years.

Falling rates will also lead to some earnings pressure. But we still assume that, even if interest rates decline, banks will be able to maintain good levels of profitability, particularly if volume growth returns.

As business volumes rise, we could see an increase in the use of SRTs (significant risk transfers) to contain the expansion of risk-weighted assets, supporting capital levels. Banks will be in a position to continue distributing profits to shareholders, combining cash dividends and share buybacks as they have been doing up to now.

How will the Middle East conflict affect banks in that region in 2025?

Mohamed Damak:  We have built four scenarios looking at how the conflict in the Middle East could evolve. These scenarios range from modest to severe risk. For both high- and severe-risk scenarios, we tested for external funding outflows and a deterioration of asset quality indicators.

For the severe-risk scenario, we also tested for local private-sector deposits outflows. The results show that only Qatar came in with a negligible deficit of around US$5 billion in external funding outflows. For the local outflows, banks can withstand our modelled outflows. Finally, for asset quality, some banks are likely to show losses because of higher provisions.

Chart 1

What is the outlook for U.S. banks' interest rate risk?

Brendan Browne:  The Fed's easing of monetary policy has supported funding and liquidity and taken some pressure off interest-rate risk management. Unrealized losses have dropped significantly from their peak as rates have come down.

But we're certainly not out of the woods. Notwithstanding the Fed rate cuts, long-term rates have come up recently, which could reverse some of the decline in unrealized losses.

We also don't know what will be the impact of the economic policies of president-elect Trump. That could lead to further volatility and long-term rate increases.

Elena Iparraguirre:  The rates cuts have already started in Europe and we expect they will continue. Banks are positioning themselves for that scenario. So any monetary-policy decision that diverges from the expected path could result in volatility and market turbulence, and maybe destabilize some financial institutions.

What is in store for Western banks with a large Asian footprint, especially in Greater China, given the outcome of the U.S. presidential election?

Emmanuel Volland:  Foreign banks do not have a very big presence in China. The U.S. election has created a period of uncertainty because we can't fully know what will be the program of president-elect Trump until he comes into power and his policies take shape.

The incoming administration has talked of imposing 60% trade tariffs on all Chinese goods coming into the U.S. We recently published an FAQ looking at this possibility, where we speculate that Chinese GDP growth could drop to below 2% in 2026 (see "How Would China Fare Under 60% U.S. Tariffs?" Nov. 17, 2024).

This is not our best-case scenario. Nevertheless, it's a possibility, and the hit on the Chinese economy would be substantial. That would be meaningful for banks in that country, whether or not they are foreign owned.

What are the main risks facing the Chinese banking sector?

Ryan Tsang:  The Chinese property sector remains a key risk area for Chinese banks. Banks have been actively managing down their exposure to the country's property sector over the past few years. We expect the Chinese banking sector's nonperforming assets to bounce between 5.5% and 5.9% over the next two years. We define nonperforming assets as reported nonperforming loans, special-mention loans, forborne loans and other problem assets.

Chinese property sales will likely continue to soften in 2025 to about Chinese renminbi (RMB) 8 trillion-RMB8.5 trillion, from 2024 sales of RMB8.5 trillion-RMB9 trillion. So there's still some room for downward movement.

Property sector sales could stabilize toward the second half of 2025 if government measures restore the confidence of homebuyers and developers. However, the biggest uncertainty regards U.S. tariffs on Chinese exports. That could hit market sentiment and consumer confidence, which may weigh heavily on property sales. In which case, we would expect the property sector downturn to last longer than we now envision, putting extra pressure on banks.

From a global perspective, which banking systems are particularly sensitive to commercial real estate (CRE) exposure?

Brendan Browne:  The U.S. certainly is sensitive to CRE exposure. Banks are gradually working through their losses. The large banks, which have proportionally lower exposure to CRE than their regional peers, are more aggressively writing down their losses.

We've taken several negative rating actions over the past couple years on regional banks with large CRE exposure. Our base case is still that lenders are going to work through this, but there's going to be pain, and it's probably going to go on for another couple years.

Chart 2

What are the Asia-Pacific risks?

Gavin Gunning:  Broadly speaking, key risks across Asia-Pacific banking are similar to those globally. The ratings outlook is generally stable but economic risks are on the downside. Property sector risks in China remain high.

The property strains are less pronounced elsewhere across most of Asia-Pacific. However, markets such Australia, New Zealand, and South Korea have high levels of household debt, which give them similarities to banking systems in Switzerland and Canada.

A key issue for Asia-Pacific banks is government indebtedness, because we view government support as key in 15 of 19 jurisdictions. Government indebtedness, and a government's capacity to backstop a banking system in a stress period, is a key assumption underpinning our assessments in Asia-Pacific.

After a strong year for Japanese banks, what are the main risks ahead?

Kensuke Sugihara:  Japan is an outlier among the developed markets in that we're about two years behind in terms of rate hikes.

Japan's policy rate has only risen to 25 basis points. We believe the very slow pace of rate hikes as well as slow but stable economic growth will probably continue to be tailwinds for the country's banking sector.

The most obvious risks we're looking at right now are the effects from the incoming U.S. administration, and specifically the possibility that tensions between the U.S. and China may spill over to the rest of Asia. The Japanese economy is quite dependent on the U.S. and Asia, so we are exposed to whatever changes play out.

How will persistently high interest rates affect Brazilian banks' profitability?

Cynthia Cohen Freue:  The central bank is raising interest rates; we expect that to continue in early 2025. The increases will put pressure on lenders. In particular, we assume persistently high provisioning will weigh on profits.

Rated banks continue to focus on larger corporates and on better credit in order to improve asset-quality metrics. However, this also intensifies competition as banks converge on the same set of quality corporate clients. To counterbalance these effects, banks are emphasizing diversification and fee income.

Chart 3

How are Gulf banks doing in their digitalization efforts?

Mohamed Damak:  GCC banks have been investing significantly in digitalization over the past decade and they are now reaping the benefits.

For example, we've seen some banks reducing their branch networks significantly and relocating staff to cheaper locations.

While digitalization can be disruptive for these banking systems, we believe that some customers still prefer traditional banking, particularly corporates and specifically for lending. The services that are being disrupted in the region are mainly services in the payment business and money transfers.

Writer: Jasper Moiseiwitsch

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