Three things that will determine future of global banking sector

Banks are centre of attention again for all the wrong reasons, but are fears overdone? City writer Graeme Evans has the latest thinking on prospects.

A recovery for banking stocks on relief at the lifeline for Credit Suisse (SIX:CSGN) was tempered today as investors came to terms with the sector’s increasingly uncertain outlook.

Shares including Barclays (LSE:BARC) and Lloyds Banking Group (LSE:LLOY) rallied after Credit Suisse eased fears of an immediate threat to the financial system by seeking up to £44.6 billion of central bank support in order to “pre-emptively” strengthen its liquidity position.

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But the rebound still left leading London-listed shares between 7% and 12% lower than where they stood before last week’s demise of SVB Financial Group (NASDAQ:SIVB).

The problems at Credit Suisse are very different to those that brought down SVB but have reminded investors of vulnerabilities in the financial system as interest rates rise.

UBS Global Wealth Management says markets are grappling with three interrelated but different issues: bank solvency, bank liquidity, and bank profitability.

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On solvency, UBS believes these fears are overdone given strong capital positions and the tight regulatory oversight of the 30 globally systemically important banks, which include Credit Suisse as well as HSBC (LSE:HSBA), Standard Chartered (LSE:STAN) and Barclays.

At the end of last year, Credit Suisse had a capital buffer of 14.1% and an average liquidity coverage ratio of 144%, which has since improved to about 150%.

UBS notes that the liquidity positions of most European banks are very strong, with support available from the Federal Reserve and US authorities to alleviate risks for US banks.

Chief investment officer Mark Haefele said: “In short, we think bank solvency fears are overdone, and most banks retain strong liquidity positions. As such, depositors in the vast majority of institutions remain well protected.

“However, a small number of individual banks may require central bank liquidity support if funding conditions remain challenging for an extended period, and profitability headwinds for the sector are mounting.”

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European banks rallied by more than 20% at the start of this year on hopes that higher interest rates would boost profitability through higher net interest margins.

And even following Wednesday’s move, the sector is still marginally up year-to-date.

UBS Global Wealth Management is neutral on European financials and least preferred on US financials, recommending that investors with excess exposure to bank equities diversify their exposure in other sectors.

On the issue of profitability, Haefele warns that some banks will be forced to further increase deposit rates to reduce the risk of outflows, while funding costs may also increase as wholesale lenders demand higher rates of return.

He added: “Banks may opt to refrain from issuing new loans, in order to boost their liquidity, and a weaker economic outlook may require banks to take more provisions against future loan losses.”