Growing anxiety about whether banks can withstand continued low interest rates and fears of a re-run of the 2008 financial crisis continued to stalk markets when shares fell to a three-year low and bank shares remained volatile.
As shares in Deutsche Bank plumbed new depths on Tuesday and the bank’s chief executive had to reassure its 100,000 staff that it was “rock solid”, concerns mounted about the health of the global banking sector.
“Many are asking ‘crisis’ questions: ‘Is there risk of a financial crisis re-run’ and ‘can a large European bank face a liquidity event’?” said analysts at Goldman Sachs.
The Goldman analysts reckon the alarm bells are ringing too loudly. They recognise that market confidence is “fast deteriorating” but point to the €800bn (£625bn) of capital that European banks have raised since the 2008 crisis as evidence that the fears are overdone – together with the fact that customers are continuing to make deposits and there are no signs of strain in the crucial money markets.
The collapse in confidence in the banking sector since the start of the year has been dramatic. Shares in Deutsche Bank have slumped by almost 40%, UniCredit of Italy is down more than 40% while Credit Suisse is down 37% . The Europe-wide Stoxx 600 banking index is down 27%.
In the UK, Standard Chartered and Barclays bothfell more than 25% while Goldman Sachs and Morgan Stanley in the US were also caught up in the rout, down 17% and 25% respectively.
Neil Dwane, a global strategist at Allianz Global Investors who is shunning bank shares, said: “I haven’t liked the banking sector since the financial crisis in Europe … but this seems to be a global phenomenon, even the apparently ‘fixed’ American [banks] have been performing poorly.”
When the US banks reported their results last month, they barely met market expectations. Major European banks such as Deutsche and Credit Suisse have recorded their first losses since the 2008 crisis. The UK’s banks publish their 2015 results in coming weeks – they will not be pretty either.
The low interest rate environment –and the realisation that rates will stay low for longer, or even fall into negative territory – is becoming to focus investors.
“It is beginning to dawn on investors that negative interest rates hurt the sector,” said Dwane. “An element of existential concern is beginning to emerge.”
The Bank of Japan and the European Central Bank are both signalling that they could embark on looser monetary policy, putting further pressure on bank profits
The last financial crisis was exacerbated by little-understood investment vehicles such as CDOs (collaterialised debt obligations), synthetic CDOs and monoline insurers. But this time the issues are more straightforward: they centre on concerns about economic growth and the impact of low oil prices. It is proving harder for banks to generate profits and is calling into question the business models of some banks – Deutsche and Barclays among them.
Ian Gordon, banks analyst at Investec said: “The thing which has genuinely deteriorated for banks is revenue, weak market-related revenue, net interest margin pressure and weak fee income.” Low interest rates make it harder for banks to make profits on their lending.
Policymakers point to a series of changes since the 2008 crisis would should make the system safer and are designed to rule out the need for further taxpayer bailouts of banks.
Last month, Andrew Bailey, a deputy governor of the Bank of England, outlined some of the key changes: “We have increased the required equity capital held by banks … We have introduced liquidity regulation designed to enable banks to withstand the loss of more footloose, short-term wholesale funding, which has gone alongside a sharp shrinkage by banks in their use of that funding.”
In the UK, banks are also being required to ringfence their high street arms from riskier investment banking operations – although they have until 2019 to do so.
Bailey pointed to the need for banks to have plans to deal with the fallout if they should ever face collapse. This is known as “a living will”. There are plans in place aimed at forcing each bank’s bondholders to absorb bank losses, rather than taxpayers.
It is this new type of bond – known as contingent capital or cocos – that are the focus of speculation swirling around Deutsche Bank. The German institution insists there is no cause for alarm and it can keep making the required payments on its coco bonds.
But for all the regulatory changes that policymakers can list, there are concerns that reforms have not gone far enough. Anat Admati of Stanford University wrote in this month’s National Institute Economic Review that the reforms had been “messy and unfocused”.
“Instead of simple and cost-effective regulations to counter distorted incentives that harm the economy, regulators have devised extremely complex regulations that may not bring enough benefit to justify the costs but will allow the pretence of action,” she said.
Tony Greenham, director of economy at the RSA, doubts that governments have the cash to bail out banks a second time. “If there is another systemic crisis it should force some more radical ideas – really break them up, introduce capital controls,” he said.
With the ugly mood in the markets, there are fears it could get worse. Banks might soon start to look at the risks they face from each other and start to question whether they should be holding positions overnight. That could precipitate a crisis.
Others point out, though, that the markets have already priced in “another global financial crisis”. Sandy Chen, a widely respected analyst at Cenkos Securities, said banks such as HSBC and Standard Chartered had fallen to their the lowest stock market valuations, as compared with the value of their assets, that he could remember in his 20 years working in the City. That, he said, indicated that the market was already prepared for them to take huge losses.
If he is right – and the markets have got the fear of a new banking crisis out of proportion – it could be time to buy those bombed-out bank shares. Said Chen: “These are the times, for a value-based investor to begin picking up bargains.”