US, not European, banks more exposed to a slump

By The Editorial Board, Financial Times

A weakening global economic outlook spells trouble for banks — even more than investors seem to believe. Years of below-target inflation have already kept interest rates at unprecedented lows, eating away at lenders’ core operating model.
Sluggish growth and prolonged uncertainty — over concerns ranging from Brexit to the US-China trade war — have sapped appetite for borrowing and investment. Europe’s globally active banks have faced an unpleasant environment for some time. 
Their dominant Wall Street rivals have instead enjoyed years of outperformance and near-record share prices. That will not make US banks more immune to a downturn. Global banks face multiple threats. Net interest margins — the differential between the cost of borrowing and the charges earned on lending — have already been whittled away. 
Central banks are set to cut interest rates further, in some cases deeper into negative territory, intensifying the margin squeeze. Passing on negative rates to corporate and wealthy private clients has acted as a partial offset, but there is no sign this can be extended to the vast retail deposit base. Investment banking — often a buttress to profits when lending rates are squeezed — is starting to suffer, too. 
Equity divisions are under secular threat as companies balk at the cost and hassle of being publicly listed, and an alternative supply of private equity money balloons. There are opportunities in this growing private equity sphere but they are likely far smaller and lumpier than the traditional business of buying and selling shares. After years of boom, cyclical downturns are looming in both equities and fixed income markets. It is a matter of how soon and how severe. 
Declines in initial public offerings, and merger and acquisition activity, are widely expected. The challenges are all the more daunting given that some of the world’s biggest banks have additional problems of their own. Deutsche Bank has just launched a vast restructuring in a belated attempt to shrink an anachronistically structured investment banking unit. 
Barclays’ prospects are overshadowed by the dark cloud of Brexit. HSBC, also afflicted by Brexit, faces the additional headache of surging political risk in Hong Kong and China. The stock market has long factored in such ills. The average large European bank is trading at less than three-quarters of its net asset value. Deutsche’s price-to-book value ratio is less than 20 per cent. 
A valuation below 100 per cent suggests either that investors believe assets are not worth what the bank says they are, or that it has no prospect of earning a satisfactory and sustainable profit. For the time being US banks look far healthier. JPMorgan, the most valuable bank in the world, has a market capitalisation of close to $340bn, nearly 1.5 times its net asset value, and nudging an all-time high. Bank bosses are well aware of the problems. 
The Financial Times reported recently that global banks are cutting 30,000 jobs. Most of those cuts are being made in Europe by European banks. Citigroup is an exception among US banks with forthcoming job cuts. Europe’s banks could now be better placed than their US rivals for the next downturn. 
Years of unfavourable conditions have arm-twisted most to become more efficient. US banks have, by contrast, enjoyed a more benign domestic market and thrived internationally. Should global activity slump there is a danger that they are more exposed, growing most aggressively at a time of risky lending terms. Europe’s banks have got used to being unloved. Wall Street’s have far further to fall.

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