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By Sebastian Angerer and Ivor Schucking
Investors seem very bearish on global banks, as if expecting a 2008-type financial crisis to return in the near term. Yet banks are in a very different place now thanks to strong fundamentals.
Global banks have not been spared by the COVID-19/coronavirus-induced fears of a global economic recession and a potential repeat of the 2008 global financial crisis. We believe that bank stakeholders have learned from the painful lessons of the past and memories of the great financial crisis (GFC) remain very much alive. However, investors now seem to be taking an extremely bearish view, expecting the rare 2008-type of financial crisis to reappear over the near term instead of a much more common economic recession. Bank stocks in both the US and Europe have fallen over 40% and bank spreads have widened to levels not seen in many years. Unlike the 2008 crisis, we expect policymakers in the US and Europe to use banks as tools to support economies. Banks are in a different place today given the adoption of a lower-risk business model, multi-decade balance sheet strength (i.e. much-improved capital, liquidity and asset quality) and the various forthcoming policy initiatives aimed at partnership with banks to help ensure economies are supported. We believe that since the GFC policymakers have learned that maintaining a functioning banking system is essential to providing the credit and confidence necessary to stabilise economies.
Bank credit fundamentals today are arguably the strongest in decades
Driven by the much stricter Basel III post-crisis regulatory framework, banks have been on a journey of de-risking and balance sheet strengthening over the last decade. For example, European banks added more than €1 trillion of capital since 2007 and US banks increased their capital base by more than $700 billion, which has led to a dramatic improvement in capital ratios (Exhibit 1). We believe the comprehensive overhaul of regulation has also led to much lower risk and a bondholder-friendly business model by endorsing and rewarding lower growth, better underwriting, more conservative capital management and fewer acquisitions.
Exhibit 1: Bank Capital Ratios