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Banking on a Positive 2013

Peter Tasou

27-Dec-2012

Peter Tasou examines the year gone by for the banking sector, the changes required in the macro-economic environment to instil stability and the hurdles that need to be overcome by UK banks in 2013.

After five years of doom and gloom, better days may at last lie ahead for UK banks, although a number of obstacles clearly remain.

Perhaps reassuringly, this is not a consensus view and a number of market participants remain underweight in the sector, with the steep losses witnessed during the peak of the credit-crunch a not so distant memory.

2012: A year of progress

Lloyds and RBS - the banks that required public investment - have made significant progress over the last few years to stabilise their Balance Sheets.

Banks globally are also benefiting from the significant provision of liquidity from central banks, which has generated high levels of cash within the financial system. Specific to the UK, the new ‘Funding for Lending’ scheme, by which banks can borrow from the Bank of England (BoE) at below market rates for specified lending, seems to have provided a boost to the sector, with credit default spreads and wholesale funding costs declining significantly in recent months. Recently the Financial Conduct Authority (FCA) has also relaxed liquidity rules for UK banks (although only on a temporary basis).

By nature, the banking sector is heavily influenced by the  macro-economic environment, both in the UK and globally. Reassuringly, the prospects for the global economy as we enter 2013 are appearing quite positive, which can only be good news for the banking sector.

Why the macro-economic environment matters

Perhaps the key development for the global economy in recent months has been a crucial step taken by the European Central Bank (ECB), which has now pledged unlimited resources towards supporting the sovereign bond markets of troubled Eurozone nations. Since this announcement, bank shares have soared, given that the probability of a Euro break-up has now diminished.

The outlook for the global economy will, as ever, also remain very dependent on developments in the US and China. With regard to the US, there have been some very positive signs that the labour and housing markets are gaining momentum, despite fears of the potential ‘Fiscal Cliff’ next year, which we still hope will be avoided. Meanwhile in China, it is hoped that after a recent slowdown, the economy is now well positioned to accelerate in 2013 under the new leadership regime.

However, despite some clearly positive developments in recent months, UK banks still face a number of challenges in the near-term.

Although the macroeconomic environment looks set to improve, growth levels are still likely to be some way below what would be expected at this stage of the global economic recovery. The risk that conditions in the Eurozone begin to deteriorate again also remains, despite the ECB recently removing some of the worst-case scenario ‘tail risks’.

2013: Potential challenges and obstacles that need to be overcome

Banks also have a long way to go towards rebuilding confidence and trust. Recent issues regarding money-laundering, PPI, LIBOR and the mis-selling of interest rate swaps have all taken their toll and banks are now paying the price through material penalty payments, which look likely to weigh on earnings for some time.

The future regulatory environment for banks is yet another area of uncertainty and perhaps the most threatening headwind facing the sector as we
enter 2013.

In addition to uncertainty surrounding Basel III and potential ‘ringfencing’, the Financial Policy Committee (FPC), which takes over from the FCA next year, has recently advocated that banks may be required to hold specific absolute levels of capital (this approach deviates from Basel III, which simply specifies targets for capital ratios) and that current capital levels may not be adequate.

This has raised the possibility that further rights issues could be around the corner, although we would view this as a last resort. The FCA will be carrying out a review of the major UK banks, with a report due in March, which will hopefully conclude how much capital, if any, banks may need.

Where next for the banking sector?

Indeed, it is crucial that the regulatory requirements for UK banks become more transparent and that this becomes apparent sooner rather than later – it is hoped that once this is achieved, the banking sector will again have the confidence to lend (if the demand is there) and provide the fuel for a UK economic recovery next year.

This article is for general guidance only and should not be relied up as constituting advice suitable to your particular circumstances. You should seek your own independent advice from a suitable professional before taking any action following this article.