A new report suggests the global banking sector will see earnings crash as a result of the Covid-19 pandemic, with the pressure likely to sound the death knell for the investment banking units of many of Europe’s big banks. The report, co-authored Morgan Stanley’s Magdalena Stoklosa and Oliver Wyman’s James David concludes that the fall-out is likely to favour scale and result in the largest U.S. banks taking greater global share.
Optimistic scenarios for a ‘v-shaped’ recession and quick rebound seeing relative normality returning within six months could still, the report argues, see banks report 100% declines in profits this year. More pessimistic scenarios for a deep global recession the report estimates the banking sector’s credit losses mushrooming to between $200 billion and $300 billion – ten times those expected in the most positive scenario.
The report doesn’t believe the capital and liquidity buffers banks have been obliged to build up over the decade and a bit since the last financial crisis will insulate the sector from a devastating drop in earnings, even if it does protect banks from the danger of insolvency. The biggest problem facing lenders is rock bottom interest rates. This means, write’s Ms Stoklosa:
“Returns have never been lower entering a major stress event and banks’ first line of defence is pre-provision profitability. The pressure on earnings could reveal structural weaknesses in some business models [ . . .] the performance gap will be wide.”
With scale the biggest single factor influencing profitability, European banks are forecast to lose market share to competition from the USA, where Morgan Stanley is the most profitable bank, Germany’s Deutsche Bank and Commerzbank are pinpointed as being in a particularly vulnerable position. Their pre-coronavirus lack of profitability leaves them with little protection to absorb a wave of defaults.
Switzerland’s UBS and Credit Suisse are, on the other hand, viewed as most strongly positioned – thanks to their strategic moves away from investment banking and greater focus on wealth and asset management. The report believes other European banks will quickly follow, significantly reducing investment banking activities in the Old Continent.
Over the past half-decade, ‘wholesale’ banks, which sell services and lend capital to other banks, have generated an average return on equity of around 10%. The report believes that will halve to between 4% and 5% over the next couple of years. For weaker banks, return on equity could drop to zero.
Eurozone banks were already only half as profitable as US peers and are likely to fall into the worst hit group. The report believes poor performance will see major investors “intensify calls for significant strategic change, potentially also acting as a catalyst for consolidation among European and tier-2 players.”
Banks also don’t have the luxury of tackling falling profits through aggressive cost cutting due to having built up higher fixed expenses as a result of regulatory and compliance demands and IT costs. Restructuring involving major redundancies is also a PR minefield in the midst of a global health crisis and likely to be avoided where possible.
Even HSBC, which had announced thousands of redundancies before the Covid-19 pandemic, has announced that it will delay the “vast majority” of those planned.
So while investment banking returns may see some initial growth as a result of the market volatility over March and into April, the overall poor performance of European investment banking units could well see more further reduced or cut as part of restructuring initiatives.