Bearish Risks in the Banking Sector Amid Rising Credit Pressures and Regulatory Headwinds

The U.S. banking sector is navigating a treacherous landscape in 2025, marked by rising credit pressures, regulatory uncertainty, and a slowing economy. While non-performing loans (NPLs) remain historically low, early signs of deterioration are emerging, particularly among interest rate-sensitive borrowers. Meanwhile, major banks are downgrading their outlooks, and regulatory shifts—though aimed at easing short-term burdens—risk amplifying systemic vulnerabilities. Investors must weigh these factors carefully as the sector faces a confluence of headwinds.

Credit Quality Erodes, Consumer Loans at Risk

According to a report by S&P Global Market Intelligence, credit risk in the banking sector has marginally worsened in 2025, with non-performing loans rising in countries like Turkey and Russia but stabilizing elsewhereBanking risk: Key themes to watch in 2025^[1]. However, the pause in U.S. interest rate easing is pressuring weaker borrowers, particularly in consumer finance. Deloitte Insights notes that delinquencies and net charge-offs have climbed modestly from 2024 levels, with credit card and auto loans expected to see sharper declines in credit quality due to strained consumer balance sheets2025 banking industry outlook^[2]. This trend is alarming, as consumer loans account for a significant portion of banks' portfolios.

The European Central Bank, as highlighted by KPMG, has emphasized the need for banks to address persistent credit risk deficiencies, including non-performing exposures (NPEs) and inadequate provisioningCredit risk landscape^[3]. While these issues are not yet systemic, they underscore a growing fragility in risk management practices.

Underperforming Bank Stocks Signal Systemic Concerns

The banking sector's struggles are reflected in stock performance. Major institutions such as BNP Paribas, Citicorp, Goldman Sachs, HSBC, JPMorgan, and Morgan Stanley have all revised their outlooks downward, citing recession risksBanking risk: Key themes to watch in 2025^[1]. The Dow Jones U.S. Bank Index has plummeted over 13% in a short span, far outpacing the broader market's 5.6% decline—a stark indicator of investor pessimismBanking risk: Key themes to watch in 2025^[1].

Fitch Ratings attributes this underperformance to a deteriorating economic environment, including rising unemployment, weak corporate earnings, and surging consumer debt2025 banking industry outlook^[2]. Labor market indicators and consumer sentiment surveys further reinforce these concerns, with the probability of missed payments reaching its highest level since April 2020Banking risk: Key themes to watch in 2025^[1]. Sectors like airlines and retail are revising earnings forecasts downward, compounding the pressure on banks' loan portfolios.

Regulatory Shifts: Short-Term Relief, Long-Term Risks

Regulatory changes in 2025 have aimed to reduce burdens on banks, particularly in digital assets and merger activity. The Office of the Comptroller of the Currency (OCC) and FDIC rescinded prior crypto-related restrictions, allowing banks to engage in such activities under standard supervisionBanking risk: Key themes to watch in 2025^[1]. While this clarity may boost innovation, it also raises questions about oversight of high-risk exposures.

In September, President Trump's executive order targeting “debanking” directed regulators to remove reputational risk from supervisory frameworksCredit risk landscape^[3]. While this could prevent financial institutions from denying services based on political or religious beliefs, it risks normalizing lending to controversial entities, potentially increasing systemic risk. The Consumer Financial Protection Bureau's (CFPB) plan to withdraw 67 guidance documents further underscores a deregulatory trendCredit risk landscape^[3].

Economic Slowdown: A Perfect Storm

Q3 2025 data reveals a fragile economic backdrop. Unemployment rose to 4.3% in August, while the Conference Board's Leading Economic Index (LEI) declined in July, signaling weaker consumer expectations and new ordersUnited States Economy at a Glance^[4]. Personal consumption expenditures (PCE) remained resilient, but corporate earnings forecasts have deteriorated, particularly in sectors reliant on discretionary spendingUS Leading Indicators^[5].

The Federal Reserve's revised stress-testing framework, set to be finalized by September 30, 2025, seeks to address these uncertaintiesBanking risk: Key themes to watch in 2025^[1]. However, the lack of clarity on future scenarios—such as a prolonged recession or inflationary shocks—leaves banks exposed.

Conclusion: Navigating the Bearish Outlook

The banking sector's bearish risks are multifaceted: rising credit pressures, regulatory ambiguity, and a slowing economy are converging to create a volatile environment. While deregulation may offer short-term relief, it risks exacerbating long-term vulnerabilities. Investors should remain cautious, particularly as underperforming bank stocks reflect broader systemic concerns. The coming months will test banks' resilience, and those with robust risk management frameworks may emerge stronger—but for now, the outlook remains cautiously bearish.