What Do Tariffs and Increased Recession Risk Mean for Banks?

Ivanna Hampton: The aftermath of President Trump’s tariffs has hit banks hard. The sector is tied to the US economy’s macro performance. A slowdown or a recession could lower profits. The tariffs come just as big banks are scheduled to report their first-quarter earnings on Friday.

Here with me to discuss this is Suryansh Sharma. He’s a senior equity analyst for Morningstar Research Services. Thanks for being here, Suryansh.

Suryansh Sharma: Thanks for having me.

Why US Banks Are Seeing Their Stocks Plunge After Trump’s Tariff Announcement

Hampton: Well, let’s get right into it. Some of the biggest names in banking are seeing their stocks plunge. Why is that happening?

Sharma: When President Trump announced the tariffs, the tariffs were significantly more aggressive than what the market had anticipated. And I think what surprised the markets were just the scope and the breadth of tariffs. So everything was targeted, all the countries were targeted, all the goods were targeted.

And now it is widely expected that if these tariffs go in place, it’s not going to be good for the US economy. It can lead to significant dislocations within certain parts of the economy. And eventually, the US banking system is connected at hip with the US economy. So the economy is not doing well, the banking system will generally not do well. I would just conclude that the US banking system just depends a lot on the macroeconomic stability, and that’s the reason we are seeing the stocks plunge.

How Do Current Market Conditions Affect US Banks’ Profits?

Hampton: How does this current situation affect their profits?

Sharma: Let’s consider a scenario where, because of this, we have an economic slowdown or a recession. In that scenario, the Federal Reserve would have to cut interest rates faster than what the market currently anticipates. And if the rates are being cut, so fed-funds rate goes down, also because of the threat of recession, the 10-year Treasury goes down: Because of the rates being cut, we can have a scenario where net interest margins for banks are materially lower than what they currently are.

Net interest margins are what the banks earn on their assets minus what they pay on their liabilities like deposits. We can also have a stagflation sort of a scenario, where the growth is very weak, the growth is anemic, but the inflation is very sticky. And in that sort of a scenario, the Fed cannot cut rates very aggressively. So we have a scenario where the fed-funds rate, or the short end of the curve, remains high, but the long end of the curve goes down. So the yield curve reverses. Now that is also not good for the banks. The reason is banks borrow on the short end of the curve through deposits, and they lend on the long end of the curve. So an inverted yield curve is not good bank names either.

If we go down the income statement, let’s now talk about fee revenues. So in fee-based revenues, as we’ve seen, the capital markets are correcting, and the asset- and wealth-management revenues are directly related on what asset valuations are. So we can see ahead in those revenues. Also after the election, I remember, I think the expectation was that we are going to get an M&A boom or an investment banking boom. It seems like we are going to get an investment banking bust. And I think investment banking is just inherently cyclical, and if we have an economic slowdown, underwriting, loan syndication, M&As, all are going to slow down. So that’s going to impact that revenue as well.

And then finally, I think when there is more uncertainty, it’s never good for loan growth. So loan growth would also be hurt. And then also, I would say credit cost is one of the biggest concerns for the market. So given the banking business model, if we have a long business cycle—let’s say it’s 15 years—so 14 out of those 15 years, your credit cost could be lower than average, but we can have one or two years where that credit cost could just spike. And I think if we move into a recession, we can see a significant spike in credit costs that impacts bank provisioning and that would directly hurt the profitability for banks.

How Banks Could Benefit From Market Volatility

Hampton: But at the same time, banks can benefit from market volatility. How so?

Sharma: I mean, that’s a very interesting question. And I think certain types of market volatility is good for banks. So especially in their trading and principle transaction business. So if there is more market volatility, it can lead to a higher bid-ask spread. It can lead to more transaction volume. It could lead to more demand for hedging instruments or derivatives.

But at the same time, we have to be careful that we don’t have a lot of volatility. So we don’t want a market crash. So because these businesses do keep a lot of securities investments on their balance sheet because they act like a principal, as a broker/dealer. And some of those securities could lose value, or they could lose a lot of money in some of the derivatives that they underwrite. So some amount of volatility is good, but we don’t want a market crash. And the current volatility that we are seeing, I would say, on a net basis, is unconditionally bad for US banks.

What to Look for in US Bank Stocks’ Q1 Earnings After Trump’s Tariff Announcement

Hampton: The big banks are scheduled to report on Friday. The big tariff announcement happened after Q1 ended. So the aftermath won’t show up in the result. What are you listening for when you hear from the bank’s management teams?

Sharma: Right. I mean, you are correct that for most … So we won’t see a lot of impact on the Q1 earnings. So we won’t see impact on revenues or fee revenues or expenses, but banks do tend to predict what will be the future loan losses, and they could increase their loan allowances for loan losses. And because of that, their provisioning can go up. So that is where we could sort of see an impact on their Q1 result. I think it’ll be really interesting to see and hear the perspective from banks on the impact on the economy if the current tariffs go in place.

Hampton: Well, Suryansh, thank you for being here today. I really appreciate your insights.

Sharma: Thanks for having me.

Hampton: Go to Morningstar.com for the latest coverage of the Trump tariffs, where our analysts are sharing insights into the market and the economy. Click on “Morningstar’s Take on Tariffs: Stock Impacts, Portfolio Tips, and More” and be sure to bookmark the page. I’m Ivanna Hampton for Morningstar.

Watch Trump’s Tariffs Upend Global Markets: Here’s What Investors Should Know for more of Morningstar’s coverage on Trump’s tariffs.