Wage inflation is becoming a bigger challenge for banks as the economy improves.

While many institutions seemed to get ahead of the issue by boosting salaries after tax reform passed, demand for higher wages will likely test an industry that worked hard to curb costs when the financial crisis put a damper on revenue growth.

Increased wages also tie into broader inflation concerns that have played a big role in recent stock market volatility.

Rising wages are good for the economy "because it means workers are doing well ... and there is healthy competition for workers," said Timothy Yeager, a finance professor at the University of Arkansas. “But the stock market doesn’t like it because profits in the future will be a bit lower. There's a tension between Main Street and Wall Street.”

A report by FIG Partners found that the banking industry's median salary rose by almost 3% last year. That increase is in line with the Labor Department's January estimate for overall annual wage growth, which was the largest since mid-2009. Also, about 40% of bankers recently surveyed by Promontory Interfinancial Network said they would pay higher wages due to recent tax reform.

A large part of the pressure is tied to high demand for top-performing commercial lenders, said David Bishop, an analyst at FIG. This could force banks to implement more in-house training to avoid having to pay more to recruit outsiders, he said.

“The industry is getting smaller,” Bishop said. “If the universe of bankers shrinks, you would think the best and the brightest, which have the strongest demand,” could command more compensation.

Due to a tight labor market, First Financial Northwest was already paying employees well above $15 an hour, the benchmark that labor activists promote for a mandatory minimum wage, said Rich Jacobson, the Renton, Wash., company's chief financial officer and chief operating officer. The company is based near Seattle, which is known for having a strong economy and is home to several technology and Fortune 500 companies.

After tax reform passed, the $1.2 billion-asset First Financial decided to award $1,000 after-tax bonuses to its roughly 138 nonexecutive employees.

“This is an incredibly competitive marketplace — one of the best markets in the country currently for business activity and housing activity,” Jacobson said. “As a result, it makes it more competitive for employees, so we're fortunate we are ahead of that game. We weren’t scrambling to move salaries up to a benchmark level.”

It can be especially daunting to recruit talent for nontraditional banking posts, including those in technology, said Christian Chandler, a partner at Hogan Lovells who specializes in executive compensation and employee benefits. Financial institutions can offer some benefits, like employee stock ownership plans and stable employment, that are not available with startups and companies in other industries, he added.

“Every industry is fighting for talent,” Chandler said. “Since the financial crisis, banks have had to try and recruit new blood and it is hard for banks, especially for the non-Wall Street banks.”

Banks may be able to offset wage inflation by continuing to close branches and lower occupancy expenses, Bishop said. The number of branches declined by about 3.5% from 2012 to 2016, to roughly 80,600, according to the most recent data from the Federal Deposit Insurance Corp. Headcount in the banking industry is down by about 1.2% over the last five years, to about 2 million employees on Sept. 30, according to FDIC data.

“There are standards you have to meet in terms of services, [the Community Reinvestment Act] and regulatory needs," which could limit how many of branches a bank might close, Bishop said. “We're not to the 'Blade Runner' stage where you have holographic images helping customers. People still like to interact with people.”

Rising salaries also seem to have spooked investors, sending the stock market on a bumpy ride for more than a week. This turmoil is at least partly related to fears that the strong economic numbers might be a precursor to inflation and a more aggressive effort by the Federal Reserve to increase interest rates.

The Nasdaq fell by about 4% last week, while the KBW Nasdaq Bank Stock Index lost roughly 4.6% of its value.

Rising rates would have a positive effect on what banks can charge for loans, said Kevin Jacques, a finance professor at Baldwin Wallace University and a former Treasury Department economist. But it would also decrease the market value of existing loans and bonds, which could be problematic for banks that have stretched on the yield curve in search of better returns, he added.

The stock market volatility is likely to continue for some time, Jacques said.

“If you study the history of the stock market, volatility tends to cluster,” Jacques added. “When something comes along that shocks markets into volatility — that can last for multiple days or even longer than that.”

A market correction is something that is actually needed because stock prices were “very much overvalued,” Yeager said.

“There are biases in how we view the stock market,” Yeager added. “You don’t see bold headlines about the market rushing to unsafe highs.”

Executives at Bank of the James in Lynchburg, Va., are focused on creating an atmosphere where employees are motivated and enjoy their jobs rather than constantly watching the stock market, said President and CEO Robert Chapman III. Chapman said he believes that taking care of employees will ensure strong financial performance for the bank that will ultimately be reflected in its stock price.

The $620 million-asset bank raised employees' minimum wage to $15 an hour after tax reform because “it was just the right thing to do” rather than because of concerns over wage inflation, Chapman said.

“Our loan pipeline is as robust as I’ve seen in my 33 years,” Chapman said. “If the economy continues to perform and our leaders in Washington don’t drop the candy and mess things up, then I think all signals are pointing to a solid 2018, at least in the markets where we are.”

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