regulation

Why Customers Will Decide The Fate Of Our Banks

This talk was given at TISA‘s Annual National Conference.

Today I’m going to try & walk the walk as well as talk the talk. To be successful, you need to focus on what it is your customers want and how do they want it.

What will separate the winners from the losers in the banking sector, is the ability to recognize what it is that customers want and delivering it.

Likewise, this session will be driven by you. I will do my best to tackle the questions you want answered. So we’ll have a look at what’s going on, why is it happening, how far have we come, where are we heading and what can we do about it?

As well as deliver it in the way you want it – the presentation will be kept short..

Firstly – what’s going on?

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Banks: Why We Can’t Use a Sledge Hammer to Correct a House of Cards

Watch this as a 1 minute clip on Newsnight

 

While banks need to earn back our respect, moves to strengthen the system should be handled sensitively.

The challenge is that a low level of regulation hasn’t worked while too heavy handed regulation could be just as damaging. Elevated regulation costs could be passed on to the consumer in terms of higher borrow costs and lower credit availability. The ‘man on the street’ may be the ultimate victim as a tougher environment leads to job losses as companies struggle to finance themselves.

The misunderstanding is that it is not as binary as ‘retail good’, ‘investment banking bad’. Ringfencing and protecting one part of the industry from its perceived higher risk other half is a flawed strategy. Good assets can go bad, as we’ve seen in Europe as certain government bonds have become less and less credit worthy, with the likelihood of default increasing. Retail banks have gone bankrupt, far from worthy of their halos. Furthermore there’s the issue of funding. Retail banks are subsidised by investment bank revenues. Therefore again, those with a high street bank account could be hit with fees to have a deposit account. Although it may be argued this cost is preferable to the possibility of greater losses from instability. Nevertheless, instead of a focus only on separation, the issues to tackle run deeper.

It’s about mitigating the risk not just moving it about. We need interests to be brought back inline & not incentivise  excessive risk taking. Nonetheless, while banks remain fragile, complex & different to each other, the situation needs to be handled carefully.

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?


Strategic Stock Selection by Gemma Godfrey on CNBC

Follow this link: CNBC Clip for a 3-minute run down of where you should be investing and what to avoid.

Incl: headwinds facing the banks (a “Tale of Two Cities: Goldman Sachs and Credit Suisse); opportunities for firms ‘ready for change’ (Apple versus Nokia) and the inflationary pressure on consumers (Pepsi and Coca-Cola)

Bank Rules: Stability Up, Profitability Down  21 Apr 2011

“I’m a little bit cautious about the sector and it will be interesting to see how (banks) are reacting to the regulation,” Gemma Godfrey, head of research at Credo Capital said of the banking sector. She added there would be more stability with higher capital requirements, but profitability would be reduced, as in the case of Credit Suisse.

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Stocks Selection – What to Watch…

Finance regulation is like airline security – defending against the last threat – Anthony Hilton, Evening Standard

Source: Alan Caruba's blog "Facts not Fantasy", http://factsnotfantasy.blogspot.com/2010_11_01_archive.html

When picking an investment focus on the ‘R’sRegulation…. Ready for change…. Robust…. and then lets not forget Rotation…!

Regardless of the validity of the above quote, a higher level of regulation should be a serious consideration when picking stocks. Which sectors are most at risk? And what qualities should a company have to be able to flourish in this environment and provide an attractive vehicle in which to invest?

Let’s focus on the 3 ‘R’s which will help guide our way…

REGULATION – Within the financial sector, this may make banks more stable but less profitable….

READY FOR CHANGE – in contrast, those firms able to adapt will flourish (implementing new technologies, entering new economies (e.g. EM), exploiting niche opportunities)

ROBUST – whilst at the same time, the need for a strong balance sheet remains crucial in order to cope with, for example, the previously mentioned less predictable Emerging Markets. In addition, in this credit-starved environment, the firms with cash to burn are in a stronger position to buy cash-strapped competitors and build market share.

Note: The Economist this month published their 2011 themes, one of which summed up the latter 2 ‘R’s by coining a new term – forecasting of the dominance of “Multinationimbles” – combining multinational reach with nimbleness in strategy. Sited as an example was IBM, celebrating its 100 year anniversary this year, shifting its focus from hardware to selling services.

Another stock example: Nokia, originally a paper manufacturer back in the 19th century, with stints in rubber and electricity generation before entering the telecommunications industry. With products winning approval for sale in China, they are continuing to look for the next opportunity from which to profit.

Source: Google Finance

Ok, before we end the article, there is one more ‘R’ to watch, on a shorter time horizon you should be aware of:

ROTATION – out of defensives and into more cyclical stocks as investors gain confidence and put risk back on the table….