Photo: Bloomberg
Photo: Bloomberg

Weak bank earnings are no surprise

The unpalatable truth is that the banking model is broken

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. Bloomberg

Mark Gilbert is a Bloomberg View columnist.

Comments are welcome at otherviews@livemint.com

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