The start of 2016 has been marked by a correction in global stocks markets, the strengthening of the U.S. dollar, increased fear of a economic slow down in China, and a drop in oil prices. However, these aren’t the only events that are a concern for investors. Banks across the globe have shown a weak performance in the last quarter, dragging stock markets down further.
Banks Are Struggling From Europe To The U.S.
Since the start of the year bank stocks have plunged across the globe. Royal Bank of Scotland’s (RBS) stock is down 27% year-to-date, while Deutsche Bank’s (DBK) share price has also plunged 27%. The Italian bank UniCredit (UCG) has lost 31% of its equity value and the French bank BNP Paribas (BNP) has seen a 15% drop in its share price. Banks’ performances in the U.S. have not differed much. Citigroup (C) shares are down 20% year-to-date, while Morgan Stanley (MS) and JPMorgan (JPM) are down 17% and 10% respectively.
Low Interest Rates
Low interest rates in the world’s leading economics are taking a toll on banking profits. While the U.S. has hiked its benchmark interest rate in December 2015 investors are currently not pricing in another hike in 2016, as the U.S. economy is not growing as fast as the Fed has hoped for.
Across the pond, the Bank of England has stated that interest rates are likely to remain low throughout the year in the U.K. and with slow economic growth in Europe the European Central Bank is unlikely to hike soon. While in Japan, the world’s third largest economy, the central bank has opted for a radical step in their monetary policy by introducing negative interest rates in an attempt to stimulate their economy.
Low interest rates are bad for banks as they hold large amounts of cash, which they deposit with the central bank. If the benchmark rate is low, this in turn yields almost no returns for banks on their cash holdings. Bank’s net interest margins, the difference between the rates at which banks will lend and borrow, therefore get squeezed, affecting banks’ profitability.
Low Oil Price
Banks, especially in the U.S., are primary lenders to the oil sector. A drop in oil price inevitably leads to bankruptcies in the oil industry. In fact, in 2015 42 oil companies filed for bankruptcy in North America. Banks, such as JPMorgan Chase (JPM), Wells Fargo (WFC) and Citigroup (C), who are sitting on billions of loan exposure to the energy sector, are forced to put funds aside to cover expected losses from defaults in their energy loan portfolios.
Increased Competition From Non-Traditional Banking Institutions
The recent boom in the FinTech sector has sparked an increase in competition for banks from non-traditional banking players. Consumers, especially from the millennial generation, are shying away from traditional banks and are opting for tech companies instead that provide financial services. For example, retail clients and SMEs, nowadays, are more inclined to use commercial currency exchange companies when they are moving funds from the U.S. to Europe, instead of their bank. Furthermore, many retail clients are now banking using their smartphones and, therefore, are happy to use online-only banks, instead of high street banks, to provide that service.
The push form tech companies into the financial services industry is taking customers away from the major banks. This is affecting retail banking profitability at many of the major banks.
Increased Costs To Comply With New Regulations
Expenditure on new risk management and control systems has increased heavily since the financial crisis of 2008 and the subsequence wave of banking regulations. Banks have needed to increase head count in non-revenue generating departments, such as risk management and compliance, to keep up with regulatory requirements.
Many banks including BNP Paribas (BNP), Deutsche Bank (DBK), Credit Suisse (CS) and Barclays (BARC) have announced that they are moving away from investment banking business as the increased regulatory costs to run that business is affecting overall bank profitability.
Slow Down In Emerging Markets
Banks, such as Citigroup (C), which have a strong foothold in emerging markets are seeing their profitability affected as many major emerging economies are witnessing a slow down in growth. The most prominent of those would be China, who has been a major driver for growth in both developed and developing countries in the last decade. A slow down in China’s growth has been a fear for global markets for a long time, but is one that is slowly coming true. This has also been weighing on banking stocks since the start of the year.
