By Phillip Mann – firstname.lastname@example.org
In 2016 to date, much of the focus within global banking has been on Europe, which has started the year poorly. Declining stocks of major lenders, most of which have hit multi-year lows, have raised significant concerns from shareholders—by early February, Deutsche Bank was down nearly 35 percent year-to-date; Societe Generale had plummeted 26 percent; BNP Paribas and Santander both lost around 24 percent; and UBS’s stock price shed just over 20 percent. UBS also recently reported a drop in fourth-quarter investment-banking revenues, which has been attributed to high costs, despite the wave of layoffs recently enacted by the Swiss lender. According to the bank, the cost-income ratio at UBS’s investment bank remains at an unsustainable 93 percent. Elsewhere, HSBC recently decided to freeze wages and hiring; Barclays recently announced it would cut 1,200 investment banking jobs; and Deutsche Bank will trim bonuses after recording a hefty loss for 2015.
While the balance sheets of US banks are now at their strongest since the financial crisis, with the bulk of fines having been paid off and the majority of stringent capital requirements having been met, European banks are still lumbered with excessive non-performing loans (NPLs), as well as being more exposed to emerging markets that have performed weakly in 2015. While the US appears to have stabilised its economy with its interest rate hike in December, the ECB (European Central Bank) recently extended its quantitative-easing program by six months, and lowered its deposit rate to -0.3 percent, which has severely constrained the region’s banking system.
According to recent analysis by hedge-fund manager and ex-Goldman Sachs analyst Raoul Pal, share prices of European banks have reached critical levels, which he attributes to European balance sheets still containing low-grade European government bonds, while negative interest rates are creating a tougher environment than for their US counterparts and is “being priced into share prices quickly”.
If interest rates go deeper into negative territory, profit margins are expected to be squeezed further, which means that declining profitability will ultimately lead to lower amounts being added to required capital buffers. In turn, this would force banks to charge their own customers for deposits, which some banks have started to implement. Indeed, the head of Swiss private bank Julius Baer recently announced that if interest rates in Europe become increasingly negative, the bank will very likely have to charge its depositors.
From a country-specific perspective, much of the concern within European banking has fallen on Italy, where the declining health in its banking system has mainly emerged due to its excessive accumulation of NPLs. Since the financial crisis, the amount of distressed loans being recorded in Italy’s banking sector (€337 billion) has been more than 30 percent of the Eurozone’s total. By early February, the Italian banking index had dropped by 20 percent for the year, while shares of Banca Monte dei Paschi di Siena, the oldest bank in the world, had fallen by 50 percent during January alone. Italy’s banking woes are also being blamed on the fragmented nature of banking in the country. Today almost 700 banks exist in Italy, with more branches than in any other developed nation, while the top three banks hold only 25 percent of total market share.
In late January, Italy reached an agreement with the EU to create a private “bad bank” that would include a state guarantee to those who bought bad loans at market prices. Unlike the public bad banks created in Ireland and Spain following the financial crisis, however, Italy’s deal excludes any sort of restructuring of participating lenders, which is expected to make Italian banking’s road to recovery more challenging.
Italy is not the only Eurozone country in which a bad bank has recently been created. Indeed, it was recently announced that the restructuring of the failing Banco Espirito Santo in late December will now be legally disputed in court. Following the creation of Novo Banco, dubbed the “good bank”, the Bank of Portugal (Banco de Portugal) is deemed to have made serious mistakes during its €2 billion recapitalization. The Portuguese central bank chose five specific senior unsecured bonds out of 40 bonds of equal rank to absorb the losses required to recapitalize Novo Banco. Bank of Portugal’s justification for the move was to protect smaller investors—the five bonds were all held by large investors. Under the central bank’s plan, every last cent of the holdings of the five bonds will be transferred to the “bad bank” and are therefore set to incur heavy losses. As such, the central bank is likely to be sued by the holders of the five bonds, particularly BlackRock and PIMCO, which own the majority of the holdings.
A bail-in mechanism is also being touted by Russia, with the country’s finance ministry having announced in early February that it would strongly consider implementing such a scheme for big depositors. This would require bondholders to bear some of the cost for those banks who are running into trouble, rather than the entire burden being put on the shoulders of the government. Indeed, it has already spent more than 1 trillion roubles on bailing out banks during the economic crisis and may now be starting to feel the pain, especially since the imposition of Western sanctions. Deputy Finance Minister Alexei Moiseev stated that the move would allow companies and big deposit holders “to become shareholders in a couple of years perspective, if the bank operates successfully”, adding that the deposit threshold being discussed for any potential bail-in scheme is around the 100 million rouble mark ($1.3 million).
The announcement follows the move by the Russian central bank only a week before to revoke the banking license of Vneshprombank, one of Russia’s 40 biggest lenders by assets. The bank is estimated to have a 187.4 billion rouble shortfall in its balance sheet.
In Asia, meanwhile, many of the recent headlines have been centred on Malaysia’s 1MDB (1Malaysia Development Berhad) scandal. The development bank, owned by the Malaysian government and established in 2009 to pay for economic development within the country, has recently had several of its accounts seized by Singaporean authorities as part of an international investigation into potential money-laundering activity related to the bank’s dealings. Singaporean officials also froze two bank accounts last year, and its central bank and police anti-fraud division have recently stated that they are “seeking information from several financial institutions…[and] are interviewing various individuals”.
Indeed, one such individual was recently revealed as Singaporean private banker Yak Yew Chee, an employee of Malaysian financier Jho Low, who has allegedly conducted a string of personal transactions with 1MDB. Officials have seized and frozen approximately S$9.7 million from 12 of Chee’s accounts in order to ascertain whether money laundering has occurred, as well as other offences, since mid-2015.
Much of the illegal activity under examination has been directly linked to the Malaysian state. It was recently revealed that nearly $4 billion, which was supposedly to be invested in Malaysian development projects, had been misappropriated from state-owned companies. Some of the money, according to the office of Singapore’s attorney general, was reportedly transferred to Swiss accounts held by former Malaysian public officials, as well as public officials from the United Arab Emirates. The Malaysian companies have not commented in response to the allegations thus far. US and Hong Kong regulators are also conducting money-laundering investigations into 1MDB. The development bank itself has stated it “remains committed to fully co-operating with any lawful authority and investigation”.
Police also launched investigations in China into fraud cases at Agricultural Bank of China and China Citic Bank at the beginning of the year, which analysts now fear could result in tighter regulation of Chinese banking and induce further stock market panic. The incidents came to light soon after China’s banking regulatory body, the China Banking Regulatory Commission (CBRC), advised the country’s lenders to strengthen internal risk-control mechanisms in the bill-financing business at the end of December, as well as suggesting that it would soon tighten industry regulations to reduce systemic risks.
The new year ushered in the news that a China Citic Bank employee had forged documents in order to obtain a money-market bill used for short-term financing; while a similar fraud case at China’s third-largest bank, Agricultural Bank of China, was uncovered later in January—employees illegally sold bills worth 3.9 billion yuan in order to invest in the stock markets. Many now believe that more cases will be exposed, which in turn will lead to tighter regulations and a drying up of liquidity in money markets.
The police investigations and the CBRC regulatory announcement have both led to a spike in money-market borrowing costs. Between January 22 and 29, the bill interest rates in the Pearl River Delta area and Yangtze River Delta increased by 13 basis points, according to data from Industrial Securities.
The only major global region that is showing signs of banking-sector improvement at present appears to be the US, but even there the results are somewhat mixed. The country’s biggest lenders reported figures broadly above expectations for last year’s final quarter, while profits came in substantially higher than predicted. The biggest US bank by assets, JPMorgan Chase, posted a record net income figure for the quarter of $24.4 billion; Bank of America recorded its best post-crisis profit level at $15.9 billion; while Citigroup’s profit of $17.1 billion was its best quarterly showing since 2006. In terms of revenues for the year, the big six—JPMorgan Chase, Bank of America, Citigroup, Goldman Sachs, Morgan Stanley and Wells Fargo—generated a combined figure of $413 billion, which was the same as that recorded for 2014. Goldman Sachs, however, has remained stagnant throughout the year. Speaking to analysts in late January, CFO Harvey Schwartz noted that revenues were around the $34 billion mark for the fourth year running, and that Goldman had “chopped a lot of wood” to prevent costs from rising.
While annual figures for 2015 show a marginal improvement on the previous year, many analysts are suggesting that the fourth-quarter earnings results are proof that US banks have finally emerged from the “post-crisis” era of regulatory fines and hefty legal expenses. However, investors still remain concerned about the banking sector’s exposure to commodities, particularly oil and gas. This was evident as banking stocks continued to be sold off even after such a positive earnings display, in line with plummeting oil prices. JPMorgan set aside more than $0.5 billion in 2015 to contain exposure to the oil and gas sector and is expected to increase this amount this year. Bank of America CFO Paul Donofrio, meanwhile, recently asserted that only 2 percent of the bank’s total loan book has exposure to the energy sector, with only 40 percent of this amount ($8.3 billion) being loans to the two high-risk sectors of the industry—exploration and production, and oil-field services.
Africa is set to lose one of its biggest banking institutions after Barclays recently announced its plans to exit from the region. The UK bank intends to reduce its 62-percent majority stake in Barclays Africa, which operates in numerous African countries including South Africa, Botswana and Kenya. The move coincides with analyst predictions of a gloomy outlook for the continent in the face of ongoing bearishness in global commodity markets. As one of the largest banks in Africa, employing 44,000 people in 1,267 branches throughout the region, Barclays Africa is now preparing to concentrate on more profitable regions as part of an overhaul under new CEO Jes Staley.
Sub-Saharan Africa’s banking sector is expected to face serious challenges as many African economies suffer weakening currencies on the back of the commodities rout. At the end of January, credit-rating agency Fitch warned that the Sub-Saharan African region is set for a downturn in 2016 and beyond, with the majority of lenders “likely to face slower growth, weaker earnings, worsening asset quality and tighter liquidity and capitalization”.
One of the few banks bigger in assets than Barclays Africa, however, is Atlas Mara, the investment-vehicle brainchild of former Barclays CEO Bob Diamond, who left the company in 2012, and Dubai-based entrepreneur Ashish Thakkar. Having already bought up banks in Botswana, Mozambique, Tanzania, Zambia, Zimbabwe and Rwanda (most recently), Atlas Mara is now looking to expand further by acquiring more African lenders in order to become the continent’s leading financial institution.
In an interview at the World Economic Forum in Davos, Diamond insisted that Africa’s expected problems in 2016 are “more about demographics than about oil”, and hinted at expansion regionally within Africa, with the next potential focus being East Africa. Diamond also recently underlined his and Thakkar’s long-term commitment to investing in Africa, despite the challenging environment that is only going to worsen. “There is no question we want to invest more. This is a great opportunity for us.”