As monetary policy eases, the U.S. banking industry may be ripe for some consolidation, particularly among community banks, says Fitch Ratings.
In a new report, the rating agency said 2025 could prove pivotal for the U.S. banking sector, with merger and acquisition (M&A) activity likely to ramp up among the thousands of smaller banks that still populate the U.S. industry.
In the past few years, consolidation in the U.S. banking industry has slowed amid the economic and financial uncertainty that accompanied the pandemic, and the effects of a sharp tightening of monetary policy that followed.
Higher rates resulted in reduced liquidity, shifts in the mark-to-market valuations of banks’ securities portfolios, and weaker credit quality, particularly in commercial real estate, Fitch noted.
Now, as monetary policy eases, some of these impediments to merger activity are expected to recede too.
With rates declining, “the industry will see a further reduction in unrealized losses in bank investment portfolios and any residual barriers to M&A activity significantly lessened,” Fitch said.
At the same time, the growing digitalization of the banking sector, “will further incentivize consolidation,” it noted.
Historically, community banks have had relatively stable technology demands, Fitch said — but that’s changing.
“In line with the broader trend of digitization, the emergence of fintech challengers and rising cybersecurity threats, virtually all banks have had to make technology investment a higher priority,” it said. And, for community banks, the rising cost of tech has become a growing concern.
“Expenditures for improved technology represent a significant investment for all banks but even more so for community banks, given their relatively small asset bases over which to spread these costs,” it said.
Additionally, smaller banks have higher fixed costs, leaving them with fewer resources for technology investment.
“Resources, including more specialized personnel, are leveraged more efficiently at scale, which could help compel consolidation,” it said. “While technology investment is one among many considerations in M&A [decisions], it is likely to grow in relative importance, particularly if the risk of major cyber events increases.”
A wild card in the M&A landscape is the outcome of the looming U.S. presidential election.
Fitch noted that the current administration has taken a tougher line on bank mergers, and so it expects that the election “will play a significant role in determining the trajectory of bank M&A.”
A second Trump administration will likely assume a similar stance to the first, in which the relaxation of regulations was a key objective.
“The outlook for a Harris administration is somewhat less clear,” it said. “The most likely assumption relating to bank M&A is that a Harris administration will continue the increased regulatory scrutiny of the Biden era.”