The three Rs behind global banks’ recovery

IN THE Bible, seven years of feast were followed by seven years of famine. For banks there have been ten lean years. Subprime-loan defaults started to rise in February 2007, causing a near-collapse of the industry in America and Europe. Next came bail-outs from governments, then years of grovelling before regulators, mass firings of staff and quarter after quarter of poor results that left banks’ shareholders disappointed. Now, a decade later, the moneylenders are quietly wondering if 2017 is the year in which their industry turns a corner.

Over the past six months the FTSE index of global bank shares has leapt by 24%. American banks have led the way, with the value of Bank of America rising by 67%, and that of JPMorgan Chase by 39%. In Europe BNP Paribas’ market value has risen by 52%. In Japan shares in the lumbering Mitsubishi UFJ Financial Group—the rich world’s biggest bank by assets—have behaved like those of a frisky internet startup; they are up by 57%. Predictions about global banks’ future returns on equity have stopped falling, note analysts at UBS, a Swiss bank. Some of the biggest casualties of the financial crisis are even expanding. On December 20th Lloyds, bailed out by British taxpayers in 2009 at a cost of $33bn, said it would buy MBNA, a credit-card firm, for $2bn.

The excitement can be explained by three Rs: rates, regulation and returns. Consider interest rates first. The slump in rates has been terrible for banks. Between 2010 and 2015, the net interest income of the rich world’s 100 biggest banks fell by $100bn, or about half of 2010 profits. When rates across the economy rise, by contrast, banks can expand margins by charging borrowers more, while passing on only some of the benefit of higher rates to depositors. So bankers have been watching the bond market with barely concealed joy. Ten-year government yields have risen by one percentage point in America, and by 0.30-0.64 points in the big euro-zone economies and Japan over the last six months. Investors are talking about a Trump-inspired “reflation”: the president-elect promises to embark on a public-spending boom. In Germany inflation is at a three-year high of 1.7%.

Banks’ CEOs are also chipper because they think that regulation has peaked. In America the new administration is likely either to repeal the Dodd-Frank act, an 848-page law from 2010, or to prod regulators to enforce it less zealously. Bank-bashing fatigue seems to have set in among the public. True, when firms misbehave, there is still a firestorm of outrage. John Stumpf, the boss of Wells Fargo, quit in October after his bank admitted creating fake accounts. But many people can see that power has migrated from banking to the technology elite in California. The brew of high pay, monopolistic tendencies and huge profits that attracts populist resentment is now more to be found in Silicon Valley than in Wall Street or the City of London.

Global supervisors are still cooking up new rules, known as “Basel 4” (see article), but are unlikely to demand a big rise in the safety buffer the industry holds in the form of capital. The strongest banks are signalling that they will lay out more in dividends and buy-backs, rather than hoard even more capital (today, the top 100 rich-world banks pay out about 40% of their profits).

A third reason for optimism in bank boardrooms is returns. Global banking’s return on equity (ROE) has crept back towards a respectable 10%. The worst of the fines imposed by American regulators are over. So far, “fintech” startups that use technology to compete with rich-world banks have not won much market share; banks have used technology to boost efficiency. They have also got better at working out which of their activities create value after adjusting for risk and the capital they tie up. Barclays, once known for cutting corners, says it can calculate the ROE generated by each of its trading clients. It is ditching 7,000 of them.

Given the giddy mood, the big danger starts with a C, for complacency. Regulators believe that banks now pose less of a threat to taxpayers. American lenders have $1.2trn of core capital, more than twice what they held in 2007. Citigroup, the most systemically important bank to be bailed out, now has three times more capital than its cumulative losses in 2008-10. European banks’ capital buffers have risen by 50% since 2007, to $1.5trn.

Yet there are still plenty of weak firms that could cause mayhem. Deutsche Bank, several Italian lenders and America’s two state-run mortgage monsters, Fannie Mae and Freddie Mac, are examples. Mega-banks may simply be too big for any mortal to control. For every dollar of assets that General Electric’s Jeff Immelt manages, Jamie Dimon at JPMorgan Chase looks after $5.

Once bitten

And banks still lack a post-crisis plan beyond cost-cutting. Despite their surging shares, most are valued at around the level they would fetch if their assets were liquidated, which hardly indicates optimism about their prospects. Before the crisis, they inflated their profits by expanding in unhealthy ways. They captured rents from state guarantees, created ever more layers of debt relative to GDP, and grew their balance-sheets by means of heavy over-borrowing. They have reversed much of this expansion over the past decade but that strategy cannot go on for ever.

In 2017 banks will need to articulate a new growth mission and show that they can expand profits without prompting public outrage or a regulatory backlash. One area of promise is the drive to raise rich-world productivity. That would boost economies broadly, and their own profits. There is plenty that banks could do: get more credit to young firms, improve payments systems so that a higher proportion of midsized firms can engage in cross-border e-commerce, and harness technology to make banking as cheap and easy to use as a smartphone app. Forward-thinking bank bosses are already emphasising such goals. If they could achieve them over the next decade, they might even realise a fourth R—redemption.