It's not a good time for banks right now, and it is likely to get worse.

Thursday, 11th July 2019 08:39 - by Shant

Never one join the chorus of naysayers when the narrative is well established, banking stocks are again in the spotlight with yet another shakedown at Deutsche Bank - one of Europe's leading lending institutions.   Job losses in the neighbourhood of 15,000 to 20,000 will be focused in the share dealing division, in a market which has undergone a major structural shift at the hands of modern technology.  In recent years, the spread of automation has reeked havoc in the industry, and as Deutsche Bank openly admit, they have not been competitive enough, and will struggle to do so - which has led to the decision to close down the department.  This is not something which is specific to Deutsche, so those banks still counting on revenue streams from trading operations need to take note.  

Consequently, Deutsche will be looking to focus on corporate banking and cash and asset management - what were, and still are seen as the safer options which we saw the banking industry as a whole focusing on in the aftermath of the financial crisis over 2007 and 2008.  That said, given the wholesale migration towards this less volatile form of income, competition has been and will continue to be tight. In light of this, the plan may be long on optimism, but the reality may soon bring expectations back down to the ground.  

However, there are more pressing concerns for banks going forward and especially for those in Europe - and that is ECB policy.  As cynical as this may sound, the ECB seem to have been quick to respond to the Fed pivot which now suggests the worlds leading central bank is set to trim the Fed funds rate.   In what many perceive as a pre-emptive strike in order to keep the exchange rate well contained, president Mario Draghi has opened the door to fresh easing - a move which drew the ire of the US president at the time. Even so, markets are now pricing in further cuts to the deposit rate and we are once again questioning the prospects of bank profiitability in a world where negative rates/yields are spreading like wildfire. 

Just how are banks supposed to thrive in this climate? In the US recently, Comerica saw a drop in stocks when markets started pricing in rate cuts after the last Fed pivot - this where Fed funds currently stands at 2.50%.  However, from that, we can assume that smaller and regional banks will take the brunt of a(n even) lower rate environment and that a fresh round of mergers is likely to emanate from this.  

How sure are we that rates are heading lower?  Well on Thursday, the chairman of the Federal Reserve Jerome Powell delivered a pretty clear message that despite the strong employment report, he believed there was little evidence for calling the labour market hot.   Wage growth has been pretty tepid considering the low level of unemployment, so there is merit in that statement.  However, the Fed chair also stated that lower inflation could work its way into lower short term rates.  This is pretty much a rubber stamp on the 25 basis point cut the market is (fully) pricing in at the end of the month.  With the US economy set to cut rates, we have a full complement of dovish central banks destined to pull rates lower. 

When we look to Europe and Japan, where there has been little or no opportunity to build up a rate buffer - though I would argue the case that the ECB had just that in 2017 and late 2018 - we can only assume that negative rates will continue and that fresh quantitative easing is back on the table.  Irrespective of the fact that lending does not necessarily lead to economic expansion, and this is a topic on its own, it does mean that banks are set to have their margins squeezed further still.  This will likely offer up opportinities for buyers and sellers, as the overwhelming likelihood is that further - or fresh - industry consolidation is likely to accelarate. 

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.