Weak bank earn­ings are no sur­prise

The Pak Banker - - OPINION - Mark Gil­bert

CALL it the new nor­mal for Euro­pean bank earn­ings. Stan­dard Char­tered shares plunged by the most in more than three years on Tues­day af­ter the bank posted a "sur­prise" 2015 pre-tax loss of $1.5 bil­lion, some­what dif­fer­ent from the $1.37 bil­lion av­er­age profit es­ti­mate from 20 an­a­lysts. On Mon­day, HSBC de­liv­ered a "sur­prise" fourth-quar­ter pre-tax loss of $858 mil­lion, rather than the ex­pected profit of $1.95 bil­lion. On 28 Jan­uary, Deutsche Bank "sur­prised" bond in­vestors with a fourth-quar­ter net loss of $2.3 bil­lion, less than two weeks af­ter tap­ping them for $1.75 bil­lion of funds. The un­palat­able truth is that the bank­ing model is bro­ken. The days of gen­er­at­ing gobs of cash from "so­cially use­less" fi­nan­cial en­gi­neer­ing, as Adair Turner put it in 2009 when he chaired the UK Fi­nan­cial Ser­vices Au­thor­ity, are over. Be­cause banks have to hold more cap­i­tal for a rainy day, they have less money to play with in fi­nan­cial mar­kets. And they are still shrink­ing their trad­ing desks, fur­ther curb­ing their abil­ity to make money from mar­kets.

Im­por­tant aspects of Europe's reg­u­la­tory back­drop re­main foggy at best; the Euro­pean Union's Mar­kets in Fi­nan­cial In­stru­ments Di­rec­tive, new rules cov­er­ing a mul­ti­tude of mar­kets from de­riv­a­tives to bonds, has been de­layed by a year to 2018. But it's clear that the EU is seek­ing to keep fi­nan­cial in­sti­tu­tions from so-called casino bank­ing as much as pos­si­ble. Pro­vi­sions for Euro­pean bank loans to oil and gas com­pa­nies are likely to climb, fur­ther crimp­ing profit. And there seems to be no end to the fines be­ing paid for rig­ging mar­kets, with set­tle­ments for fak­ing prices for gold, sil­ver, plat­inum, pal­la­dium and de­riv­a­tive-mar­ket bench­marks still loom­ing. So, it's lit­tle won­der that Europe's banks have lost about 30% of their value in the past year. More­over, there's scant prospect that an im­prove­ment in the eco­nomic back­drop will make life any eas­ier for the banks. Bank of Eng­land gov­er­nor Mark Car­ney pointed out in tes­ti­mony be­fore the UK Par­lia­ment's Trea­sury Com­mit­tee on Tues­day that even though post-cri­sis bal­ance sheets are more ro­bust, the in­dus­try hasn't de­vel­oped a strat­egy to cope with the cur­rent en­vi­ron­ment.

The fun­da­men­tal con­cerns are about the re­turns of th­ese in­sti­tu­tions. Many of th­ese in­sti­tu­tions have not de­vel­oped the busi­ness mod­els that are con­sis­tent with a low growth, low in­ter­est rate en­vi­ron­ment, and con­sis­tent with mak­ing re­turns that share­hold­ers ex­pect un­der the new reg­u­la­tory con­struct. Cen­tral bank in­ter­est rates at near or below zero de­liver cheap money. But longer-term rates also at record lows and in many cases below zero (five-year Ger­man govern­ment bonds yield -0.33%) mean banks can't bor­row cheaply and profit from lend­ing to their cus­tomers at in­flated rates. And the fu­tures mar­ket says the Euro­pean Cen­tral Bank will drive its bench­mark rate even fur­ther into neg­a­tive ter­ri­tory when it meets next month. There's a strong ar­gu­ment to be made that the post-cri­sis back­lash against banks and bankers is hav­ing the un­in­tended con­se­quence of mak­ing the fi­nance in­dus­try less fit for pur­pose, not more. A fall­ing tide low­ers all boats, and banks that are see­ing their mar­ket cap­i­tal­iza­tion trashed are less likely to fuel the eco­nomic re­bound cen­tral bankers are hop­ing for. Un­til the pen­du­lum swings away from its cur­rent tra­jec­tory to­wards tighter regulation and stricter cap­i­tal stan­dards, Euro­pean bank in­vestors should re­sign them­selves to dis­ap­point­ing prof­its-and stop be­ing sur­prised that the world of fi­nance is strug­gling with its new nor­mal.

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