For Immediate Release
Chicago, IL – October 03, 2016 – Today, Zacks Equity Research discusses the U.S. Machinery, including Barclays (LON:BARC) (NYSE:BCS -Free Report), Deutsche Bank (DE:DBKGn) (NYSE:DB -Free Report), Credit Suisse (SIX:CSGN) (NYSE:CS -Free Report), Mitsubishi UFJ Financial Group, Inc. (NYSE:MTU -Free Report) and Mizuho Financial Group, Inc. (NYSE:MFG - Free Report).
Industry: Foreign Banks
Link: https://www.zacks.com/commentary/91852/foreign-banks-stock-outlook---september-2016
Most foreign banks are still reeling under the impact of the global economic slowdown. In the developed nations, persistently low interest rates and subdued loan growth have been taking a heavy toll on banks. Coming to emerging markets, banks are primarily being hurt by corporates staying away from loans due to higher borrowing costs and a significant outflow of capital from their economies.
Moreover, recovery prospects of foreign banks appear bleak as global economic growth may slacken further. The latest global growth projection by the World Bank indicates a derailed recovery ahead. In Jun 2016, the bank revised down the growth forecast by 0.5 percentage points to 2.4% for this year and 0.3 percentage points to 2.8% for 2017.
Major downward revisions in growth forecasts were made for commodity exporting economies such as Brazil, Russia, Nigeria and Angola due to a downswing in commodity prices, weakening currencies and higher borrowing costs.
Japan’s growth forecast for this year was also cut by 0.1 percentage point to 0.5% on concerns that its negative-rate environment will fail to boost the economy.
However, China, the second largest economy of the world, has not seen a forecast revision by the World Bank. China is still expected to grow 6.7% with the help of its stimulus.
Further, the World Bank economists are concerned about the Federal Reserve’s faster-than-expected actions in raising rates causing a huge increase in borrowing costs. This might dampen growth in economies across the globe.
Dark Cloud Over Banks in Key Nations
The major European banks including Barclays (NYSE:BCS -Free Report), Deutsche Bank (NYSE:DB -Free Report) and Credit Suisse (NYSE:CS - Free Report) have lost significant value over the past year due to a dearth of business following negative rates and economic woes. The negative rates are forcing them to lend money to corporates and individuals, but this is not helping them in generating decent returns.
Moreover, the U.K. referendum to exit the European Union heightened their risks. Along with Brexit-driven uncertainties, bad assets on balance sheets and an unfavorable rate environment will hinder European banks from showing signs of improvement any time soon.
The prospects of the banks in Japan remained uncertain with the central bank leaving the interest rate unchanged at negative 0.1% at its Sep 2016 meeting. Though the central bank will introduce “yield-curve control” as part of its major policy overhaul to fight deflation, it is unlikely to benefit the banking system in the nation.
Further, in Jun 2016, Fitch Ratings has revised the rating outlooks for Japan’s mega banks including Mitsubishi UFJ Financial Group, Inc. (NYSE:MTU - Free Report) and Mizuho Financial Group, Inc. (NYSE:MFG - Free Report) to “negative” from “stable.”
After a number of rate cuts last year in an effort to stimulate the economy, the benchmark rate in China currently stands at 4.35%, which is not unfavorable for its banks. However, the nation’s banks may not get any further support on the rate front as the central bank may not be able to raise rates any time soon. On the other hand, the economy’s credit vulnerability could be dangerous for its banking system.
Prospects Look Worse for Emerging Market Banks
Banks in emerging markets will continue to suffer as their economies are witnessing huge capital outflow. Further, an increase in interest rates in the U.S. will lead to a capital flight from these markets. As money from these economies move to the U.S. for the benefit of higher rates, matters will be even worse for these economies and their banks. This would dry up the liquidity of banks in these regions.
Further, the U.S. rate hike will make borrowing costlier and a strengthening dollar will make loan repayment expensive for these economies.
Foreign Banks Vulnerable to Weak Macro Backdrop
Growth driven by low oil prices will definitely support foreign banks with business gains. But a low interest rate environment as a result of loose monetary policy in the developed economies will continue to mar the rate-sensitive portion of their revenues.
On the other hand, any action to lower interest rates in emerging markets that have a tight monetary policy and high inflation (like Brazil) could aggravate inflation issues. This, in turn, would take a toll on their banks.
Overall, the weakness in the global financial system is likely to keep the backdrop cluttered for foreign banks.
Business Realignment May Fall Short in Keeping Banks Afloat
Foreign banks keep repositioning business fundamentals to protect themselves from further crises. Defensive actions like limiting expenses by contracting operations and retrenching workforce are still in place, and the focus on noninterest income is extending. But sluggish business activity due to economic disorder, margin compression and slothful loan growth remain serious dampeners.
Capital efficiency remains the key to survival, and most foreign banks have been strengthening their capital ratios by selling non-core assets for quite some time. Further, banks will continue to improve solvency and balance sheet liquidity as they move closer to comply with the Basel III requirements. While this will make their businesses safer, growth prospects are dull with thinning sources of income.
Immense Pressure on Revenues
The interest rate environment in developed nations (except the U.S.) is not expected to revive any time soon. Naturally, interest-sensitive revenues for banks in these regions are likely remain under pressure. At the same time, their non-interest revenue sources will be limited by regulatory restrictions.
Banks in consumption-driven economies, however, may not be significantly challenged by interest income due to a not-too-low interest rate environment which is needed to keep inflation at check. However, these banks will have no respite from the nagging non-interest revenue challenges. Further, the expected capital outflows from these economies with rising interest rates in the U.S. will add to their woes. Also, intense competition from domestic and foreign players will continue to hinder revenue generation.
New Threats to Banks
FinTech Posing Threat to Banks: The emergence of financial technology companies (known as FinTech), which offer an array of financial services through mobile and cloud computing, is a significant threat to banks. Experts predict growth of FinTech to make traditional branch-based banks redundant in the next 10 years.
Cyber-Crime to Increasingly Hurt Banks: As banks are gradually becoming more technology dependent to suit the changing mindset of the new generation with respect to money, the threats of cyber-crime are increasing.
Localization of Banking
Tight regulation is gradually making globalization of banking a thing of the past. Global banks have been curtailing their exposure to certain countries since the financial crisis due to lack of efficiency and reduced profitability following stringent regulation.
Particularly, stricter capital and liquidity requirements, and segregation of business lines based on the needs of respective countries are hurting foreign banking operations in many economies.
Effect of Regulation
The impact of tighter regulations is yet to be fully felt, with many rules pending implementation across jurisdictions. Continued attempts on strict capital standards by regulators worldwide to clip the risk-taking attitude of banks and prevent the recurrence of a global financial crisis will restrain the potential of industry players far and wide.
The final rules (issued on Nov 9, 2015) of the Financial Stability Board, which was created by the Group of 20 nations (G-20) to keep banks’ reckless behavior in check, require 30 global systematically important banks – that the Basel Committee believes are at risk of turning to too big to fail – to maintain a loss-absorbing capacity ratio (capital plus senior debt/total risk-weighted assets) of at least 16% from Jan 1, 2019. The requirement will increase to at least 18% from Jan 1, 2022. It’s quite likely that these banks will have to issue new debt to meet these requirements.
Further, the full implementation of the Basel III standards – the risk-proof capital standard agreed upon by regulators across the globe – is due in 2019. The primary requirement for banks is to maintain a minimum total capital ratio of 10.5% by 2019. Though the majority of foreign banks have made significant progress in meeting new liquidity rules, they are yet to fully comply with the standards. So the pressure on capital structure will continue for some time and banks will be less flexible in terms of business investments.
Bottom Line
The rate-hike stance of the Fed is posing near-term concerns over funding insufficiency in other economies and their banks will bear the brunt. Moreover, the not-so-effective cost-control measures and limited access to revenue sources will restrict bottom-line improvement of foreign banks in the upcoming quarters.
Of course, cost reduction by job cuts and asset sales have been instrumental keeping foreign banks afloat, but these strategies may no longer be enough. Instead, the aim should be to enhance operational efficiency through fundamental changes in business models.
However, it’s not easy to deal with an unfavorable macro backdrop. So it’s actually time to play defensive and modify products to meet evolving customer preferences.
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