Banks are bleeding shareholders
There has been a lot of discussion about the bank stock sell-off in the media. A lot of analysts and journalists have been wondering what’s going on in face of what looks like an overreaction. I don’t have an answer to that question, as I’m not sure that fundamentals justify that sell-off. Perhaps some hedge funds and speculators have been temporarily amplifying the fluctuations. But I’m not omniscient and it is possible markets have noticed something that I missed.
What I believe though, is that this sell-off has been artificially exacerbated by traditional bank shareholders, who can’t stand that situation anymore, in particular in Europe. What I mean by ‘that situation’ is everything that’s been happening to the banking sector since the crisis.
Imagine that you’re a bank shareholder. The bank you invested in survived the crisis but stopped paying dividends to you and left you with a deep negative return on your portfolio of shares. In order to start growing again and comply with new regulatory requirements, the bank asks you to invest more capital, promising a return to profitability soon. You are glad the institution survived the crisis, which may signal its superior risk management relative to competitors, so you provide that extra capital.
Unfortunately, regulation tightens further and central banks push interest rates down, sometimes into negative territory, compressing the bank’s net interest margin and depressing its profitability. To cope with this temporary pressure, the bank asks you to invest a little bit more capital, possibly in one of those new fancy hybrid capital instruments that pay high coupons without diluting the equity holder base. Fine you think, it’s for a good reason: this will be a temporary pain to bear in order to stimulate the economy and make the financial system safer, which should soon lead to prospects of higher and more stable return.
Unfortunately, authorities and regulators in a multitude of countries believe this time to be appropriate to fine banks, including yours, for past and current misbehaviour, leading to your bank’s capitalisation weakening again. A little bit annoyed, you tell yourself that it is the last time you inject extra capital into that bank. And anyway, what else could happen? You’ve pretty much lived through everything now.
Unfortunately, far from improving under all the central bank stimulus, the economy of a number of countries start declining, leading to fears for the world economy. In case of a global, or multi-country, recession, the banking sector is likely to make some losses, prompting some investors to sell their shares. As a result, the bank you invested in is likely to ask you for some extra capital sooner or later. No gain on your portfolio is in sight. “I’m out” you say, fed up.
The past eight years have been so badly managed by policymakers, central bankers and regulators, that I hope it’s going to enter history books as a good example of what not to do following a large systemic financial crisis.
Whether or not one wishes to increase the regulatory oversight of the financial sector, the worst possible time to do it is while surviving banks’ health remains extremely weak. Bankers, not only have to deal with legacy issues on their own balance sheet, but also have to implement fundamental and very disruptive changes to the same balance sheet.
Add in very low internal capital generation due to depressed profitability in a low interest rate environment (and amid the exit of a number of now unprofitable businesses), as well as huge fines that literally disintegrate capital*, and you end up with a banking sector that cannot comply with regulators’ constant demands without continuously raising capital from their existing (or new) shareholders without ever rewarding them.
Policymakers seem not to have understood one of the main tenets of capitalism: opportunity cost. There is no point, as an investor, to become a shareholder in an institution that cannot generate even close to its cost of capital in the long run. And, relative to 2008, the long run is now.
As I have repeatedly said on this blog, you can’t get a healthy economy without a healthy banking system. And a healthy banking system implies generating return around the cost of capital. It does not imply bashing banks and trying to transform them regardless of the consequences over a fifteen-year period.
In an effort to strengthen the banking system’s balance sheet and punish bankers for their alleged past behaviour, policymakers have forgotten the most important component of the system, without which there is no bank in the first place: the shareholder.
Without shareholder, no private enterprise. And banks are starting to bleed shareholders.