RBS

Crisis – Coming To A Bank Near You…

Diamonds Aren’t Forever and The Damage Could be Drastic

It appears that ‘diamonds aren’t forever’ as Bob Diamond steps down from his role as the CEO of Barclays Bank, amid investigations into interest rate manipulation. Instead, disruptions to the banking industry will be widespread and with far reaching consequences. Damage to confidence could reign in credit availability even further, lead to job losses and even affect our standing within Europe.

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Could I Have Been Affected?

With between 200 and 250 thousand mortgages linked to the benchmark interest rate (Libor), many may have been affected by rate manipulations. However, it is unclear whether they would have lost out or benefited from the activity. Barclays traders have been accused of both pushing up the rate, as well as pushing it down. Depending on the environment, on some days it would have been better to borrow at cheaper rates, and on others to earn more when lending.

Who’s Next?

Barclays is not alone. The investigation into interest rate manipulation has already touched 18financial institutions, with 12 having fired or suspended employees. Furthermore, in addition to scrutiny from the regulators, many banks face private lawsuits as well. RBS is a prime example. After having terminated or suspended at least 4 employees, the bank is facing a wrongful dismissal lawsuit from one of them claiming they were used as a ‘scapegoat’.

Lending & Employment the True Victims

The banking industry is the largest private sector employer, providing over 1 million people with jobs. Already struggling with low trading volumes, low merger & acquisition activity, weak economic growth and tighter regulation costs, Credit Suisse is rumoured to be planning to cut a third of their senior roles in Europe. As Barclays agrees to pay a $451m settlement as a result of these investigations, we see a glimpse of the additional burden banks will have to bear and the further cost and job cutting that may result.

In this environment, banks will not be encouraged to lend. Lending: More than £100bn of lending has already been withdrawn from the economy in the last 4 years, regardless of the Bank of England pumping over £300bn into the economy. Small firms are being asked to pay higher rates to borrow and keeping in mind they create the majority of new jobs, again the outlook for employment is worrying. As Chancellor Osborne asserted “What we don’t need is (the banking industry’s) reputation tarnished” instead “we need Barclays to be focused on lending”.

Support for a Banking Union?

As an example of insufficient oversight, these investigations could heat up the debate between those wishing to maintain a level of independence and authority over our banks against those in favour of our participation a Banking Union. This would involve a single regulator to oversee banks across Europe and answer calls for greater control over the banks. However, with the situation in Europe deteriorating, as unemployment continues to rise and debt burdens remain a challenge, there has been opposition towards greater integration.

The spotlight is well and truly back on the banks. Investigations must be handled carefully otherwise it could be the ‘man on the street’ that will feel the consequences.

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Banks Slash Jobs but Severe Headwinds Remain

As banks all over the world slash jobs, we ask ourselves – will this produce more streamline firms ready to generate significant profits, or a sign of the poor outlook for the sector? Unfortunately, stifling regulation repressive and a false bubble has driven this move and severe headwinds remain through exposure to struggling economies and substantial funding needs.

The 50 largest banks around the world have announced almost 60,000 job cuts. UBS are laying off 5.3% of their workforce, blaming stricter capital requirements and slowdown in client trading activity; Credit Suisse cutting jobs by 4% to save SFr1bn and Lloyds a whopping 14%.

Restrictive regulation make banks more stable but less profitable

Stricter capital requirements were just the type of new regulatory measures the Chief Executive of Standard Chartered feared at Davos back in January, would “stifle growth”. At this time we saw banks such as Credit Suisse missing earnings targets and downgrade their expectations severely going forward (from above 18% return on equity to 15%, which turned out to still be too high).

UBS has seen costs in their investment banking division soar to 77% of income and net profit fall almost 50% from a year earlier. Stricter capital requirements mean banks have to hold a higher amount of capital in order to honour withdrawals if hit with operating losses. Furthermore, restrictions on bonuses led to increases in fixed salaries and an inflexible cost base.

Backtracking on a false bubble

Job cuts should also be set within the context of occurring after a ‘false bubble’. Post the 2008 financial crisis and bank bankruptcies and proprietary trading layoffs, the fixed income, currency and commodity business of the remaining players boomed as competition dropped. Banks began expanding. UBS’s proposed cuts of 3,500 jobs comes after an expansion of 1,700 to the workforce and incomparable to the 18,500 job losses experienced during the crisis.

Exposure to struggling economies is a key threat

Crucially, these cuts do nothing to solve the biggest problem these banks are struggling with. They have substantial exposure to struggling EU economies. In Germany, bank exposure to the PIIGS (Portugal, Italy, Ireland and Spain) amounts to more than 18% of the countries GDP. Just last month Commerzbank suffered a €760m write-down from holding debt that is unlikely to be repaid, which all but wiped out their entire earnings for the second quarter of the year. Further fuelling fear of the spread of the crisis from periphery to core is that French banks are among the largest holders of Greek debt.

Here in the UK we’re by no means immune. Our banks have £100bn connected to the fate of these periphery economies. RBS, 83% owned by the British taxpayer is so heavily exposed to Greek debt that it has written off £733m so far this year.

Severe funding needs and fear of lending exacerbate the problem

90 EU banks need to roll €5.4tn over the next 24 months. This will be funded at higher rates and with disappearing demand as investors become more wary, exacerbating the problem. In addition these banks need to raise an extra $100bn by the end of the year. An inability to borrow to satisfy current obligations, not withstanding any expansive moves, is a serious obstacle to profit generation. 

Moreover, job cuts do nothing to boost confidence to encourage banks to lend. Just two weeks ago, EU banks deposited €107bn with the European Central Bank overnight than lend to each other. If banks are not even lending to each other, losing out on a valuable opportunity to make money, then how encouraged are we as investors to get involved?