broken piggy banks

The Big Banks Are Feeling the Squeeze

February 10th, 2016 by

How the mighty have fallen.

broken banking industryPrior to the onset of the financial crisis, the world’s biggest banks were the ideal poster children for the top-heavy disparity between “the 1%” and everyone else. In fact, thanks to the widespread bailouts of the financial industry, these banks remained Kings of the Sandbox in the 5 or so years following the depths of the crisis.

Recall the massive fines paid by the biggest banks in connection to manipulation and rigging scandals, from Libor to precious metals prices. We can assume that these banks performed cost-benefit analyses about whether or not to break the rules beforehand; they must have concluded that their bottom lines would improve even with the impact of massive penalties. Even with the fines, things were very good for the banks.

That is finally starting to change, as tighter regulations and new constraints are eating into these big banks’ total revenues.

The Good Times Are Over

This new reality for the banking sector—as we’ll see, especially within the European Union—is not a simple function of a poor economy. Sure, economic conditions have been stagnant in the eurozone for the past several years; but the banks aren’t suffering because the broader economy is failing them. Rather, growth has continued at a slow pace while the banks have seen their profit margins shrink.

The chart below compares how a stock index of European banks compares to their counterparts from other sectors across Europe.

big Banks stocks vs. other sectors.

Bank stocks vs. other sectors.

While bank stocks generally traded higher than other equities in the 10 years prior to the financial meltdown in 2008, they have since trailed well below other sectors of the economy. That margin has been widening, as well: as other industries see gradual improvement, banks continue to peter along.

Big Banks Feel Regulatory Squeeze

Naturally, central banks and industry regulators have tightened the clamps on large banking institutions in order to decrease the odds of another crisis that puts the entire financial system at risk. Greater capital requirements, more scrutiny over risky asset and financial products, downsized balance sheets, and a general distrust of how ethically the big banks behave have all contributed to slimmer profits for the titans of the banking industry.

bankConsumers probably won’t be complaining that megabanks like Deutsche Bank (Germany) and Credit Suisse (Switzerland) are seeing their weakest stock prices since 1992 and 1991, respectively. This is looking more and more like a sign that the commercial-investment bank hybrid business model is dying. Consumer-focused banks like Barclays (U.K.) and BNP Paribas (France) have fared far better.

Weak inflation and extremely low interest rates are also making it harder for big banks to simply arbitrage their way to riches. In fact, benchmark lending and interest rates across Europe are negative; most sovereign bond yields are negative as far out as 10 years, as well. According to the Wall Street Journal, the widespread negative rate trend could continue deeper into the red than people think.

Even though the notion that central banks reliably police the largest financial institutions within their system is dubious, it’s still an encouraging sign that effective regulations—as opposed to simply more regulations—is finally forcing banks to rethink their business models.

 

The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.