The Resurgence of Big Banks: Echoes of 1995 or a Mirage?

The financial landscape is once again abuzz with speculation about the potential for a repeat of the banking industry's golden era in 1995. As the Federal Reserve contemplates interest rate cuts, Wall Street is eagerly anticipating a scenario that could mirror the remarkable performance of the banking sector two and a half decades ago. However, the current economic landscape presents both similarities and stark differences, leaving industry experts divided on the likelihood of history truly repeating itself.

Chasing the Dream of 1995: Can Banks Recapture the Glory?

The 1995 Playbook: Lessons from the Past

In 1995, the Federal Reserve's decision to cut interest rates sparked a remarkable resurgence in the banking industry. An index broadly tracking the sector surged by over 40%, outperforming the broader S&P 500 index. This outperformance continued for two more years, making 1995 a pivotal year in the industry's history.The factors that aligned to create this banking boom were multifaceted. The industry had faced a rough start to the year, with major institutions like the municipality of Orange County, California, declaring bankruptcy and British merchant bank Barings collapsing. Additionally, the bond market had experienced a significant wipeout the previous year, and commercial real estate lenders were still grappling with the aftermath of a crisis that had begun in the late 1980s.However, a crucial factor that allowed banks to thrive was the wider margin between short-term and long-term interest rates. While the longer-term 10-year Treasury yield plunged by 250 basis points, it remained higher than short-term notes, enabling banks to profit from the difference between their borrowing and lending rates.

Regulatory Shifts: A Double-Edged Sword

Alongside the favorable interest rate environment, the banking industry also benefited from a period of regulatory loosening. In the year prior, a federal law signed by then-President Bill Clinton had eliminated restrictions that had previously prevented banks from opening branches across state lines. This set the stage for a deregulatory era that would eventually give rise to the country's mega-banks, such as Wells Fargo and Bank of America.Today, the regulatory landscape has shifted once again, with some experts suggesting that the "pendulum may be swinging back" towards a more accommodative environment for banks. While regulation has tightened since the Trump administration, big banks have become more assertive in challenging regulators on various issues. Additionally, the Supreme Court's decision to strike down the Chevron doctrine, which had previously given regulators deference in more legally ambiguous disputes, has further tilted the scales in favor of the banking industry.

The Current Landscape: Similarities and Differences

As the banking industry contemplates the possibility of a repeat of the 1995 success story, there are both similarities and stark differences to consider. The current shift in monetary policy follows one of the longest periods of low interest rates in U.S. history, a stark contrast to the environment in 1995. Additionally, the pandemic-driven surge in deposits has left many lenders poorly positioned to adapt to the significant rate increases that have occurred."There's no argument that the falling rates are good for banks. I'm just not sure that it's for the same reasons that it was in '95," said Allen Puwalski, chief investment officer and co-portfolio manager at Cybiont Capital.The path forward for the banking industry in 2025 remains uncertain. While some executives, such as Bank of America's CEO Brian Moynihan and PNC's CEO Bill Demchak, have expressed optimism about improved earnings, others, like JPMorgan Chase's COO Daniel Pinto, have cautioned that analysts may be "a bit too optimistic" about the industry's prospects.

The Soft Landing Conundrum

For the banking industry to experience a repeat of the 1995 success, the Federal Reserve will first need to navigate a delicate "soft landing" scenario, successfully bringing down inflation without causing an economic downturn. This challenge is not without its risks, as former Federal Reserve Bank of Boston president Eric Rosengren acknowledged, stating, "There are plenty of things that could go wrong."However, Rosengren also expressed optimism, noting that the probability of a soft landing is "high enough" to warrant reasonable discussion. The industry's performance in the coming years will largely depend on the Fed's ability to strike the right balance and avoid a more severe economic contraction.

Navigating the Shifting Tides: Opportunities and Challenges

As the banking industry looks to the future, it faces a mix of opportunities and challenges. While the potential for a repeat of the 1995 success may be a "moonshot scenario," the industry is already off to a decent start in 2023, with the banking index up more than 14% and the regional bank-focused index up 8%.However, the path ahead is not without its obstacles. Analysts like Gerard Cassidy of RBC Capital Markets expect banks to face higher revenues next year but also more credit problems, with incrementally higher loan loss provisions anticipated.The banking industry's ability to navigate these shifting tides will be crucial in determining its performance in the years ahead. Whether the industry can recapture the glory of 1995 remains to be seen, but one thing is clear: the financial landscape is once again in flux, and the banking sector's resilience will be put to the test.