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雷达卡
The not-for-profit sector
NARY a cucumber sandwich was thrown and the heckling was rather subdued. But the genteel rebellion over executive pay at the Barclays shareholders’ meeting in London last month, an echo of similar disquiet at annual meetings in America (see article), shows how fed up bank investors have become with their returns.
No wonder. Between 2007 and the end of last year shareholders in banks globally have lost almost 10% of their investment each year, according to the Boston Consulting Group (see chart 1). Behind this international average lie some truly horrible losses. Investors who stuck it out in Dutch banks saw the value of their holdings fall by almost 28% a year. Holders of French, German and Swiss banks suffered average annual losses of close to 20%. Those in American and British banks lost 14% and 16% a year respectively. “The little secret to doing well…has been ‘just don’t hold banks’,” says Jacob de Tusch-Lec, a fund manager at Artemis.
A fall in the price of an asset is usually a good signal to consider buying it. But those investors who thought that they had timed the bottom of the market have been proved wrong again and again. “I’ve been dipping in and out of Italian banks but am keeping very quiet about it,” says one fund manager. “Last year when I told an investor [in my fund] that I was holding some he got up and left the room.”
Such sharp falls in shareholder value are not just distressing for investors. They should also worry the businesses and households that need a healthy banking system to keep credit flowing. If the shares and debt issued by banks are uninvestible, then over time the banking system will have to shrink or be nationalised.
There are three reasons why the banks have been such a bad bet. The first is weakness in Western economies, which has led to elevated losses, subdued demand for credit and deleveraging by the banks themselves. With returns on assets remaining largely unchanged (this is a tough time to charge customers more), the industry’s total profits are likely to keep falling.
A second reason is worries about sovereign defaults. In the second half of last year European banks sold virtually none of the long-term bonds that they use, alongside deposits, to finance loans. These markets have thawed slightly since the European Central Bank (ECB) provided more than 1 trillion Euro ($1.3 trillion) in three-year loans to European banks. But they are still fragile, partly because banks have pledged collateral to the ECB, leaving less to repay bondholders if a bank were to go bust. Simon Samuels, an analyst at Barclays, points out that almost five years since the start of the financial crisis, European banks are more dependent on state support than ever. “What we have, in effect, is nationalisation via the debt markets,” he says. “If you can’t get a private-sector debt model to work then there is no real investible equity.”
The weak economy and worries over the euro area are, with some luck, transient problems. Yet weighing on investors’ minds is a third concern: the impact that regulation will have on banks’ long-term profitability and the safety of their debt. Returns on equity have fallen precipitously, from about 15% before the crisis to below 10% now. British banks’ returns have slipped from almost 20% to about 5% last year (see chart 2).
A big reason is that banks have to hold much more equity as a buffer against losses. Simple arithmetics dictates that returns must fall. Other regulations to make banks safer also have a cost. Banks will have to hold many more liquid assets, which can be quickly sold. They are also being forced to stop profitable (if risky) activities such as proprietary trading.
Rules aimed at ring-fencing retail banks, “bailing in” bondholders and making banks easier to wind up if they fail are also pushing up banks’ funding costs and depressing returns. They are doing little to encourage investors to buy bank bonds. “If regulators told European banks to raise bail-in debt there would be a resounding clatter of pennies at the bottom of the tin but no folding money at all,” says the chairman of a large bank.
For all the gloom, most big banks are still forecasting (or at least aiming for) returns on equity of 12-15%, which would handily cover the cost of their capital. That would also be respectable by historical standards: Autonomous Research reckons that over the long term banks’ returns have averaged 10% in Britain and 9% in America. But it invites two questions.
The first is whether banks can attract investors with a combination of utility-like returns and bank-like volatility. Regulators hope better-capitalised banks will be less volatile and more attractive. More pragmatically, index-tracking investors may have little choice but to hold them.
The second is whether banks can juice their returns by managing costs better. There is plenty of room to do so, particularly in wholesale banking. The Boston Consulting Group reckons that investment banks can quickly cut 10-15% of fat in areas such as market data and exchange fees. Deeper savings can be made by reducing layers of management and title creep: it found that almost half of the staff in second-tier investment banks had the title of director or managing director compared with 20-30% among the better firms.
But banks do not have a great record as beancounters. European lenders have managed to reduce their overall cost-to-income ratio only to about 62% from 69% since the mid-1990s, an average improvement of 0.3% a year. Their current targets assume an average improvement of 2.7% a year over the next three years, a figure Mr Samuels thinks looks “far too ambitious”. To keep shareholders and creditors interested, they may have little choice.
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