October 22, 2013 10:30 am

Banks worry regulation will crimp recovery

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Antonio Horta Osario CEO Lloyds Bank 10/10/13 At their Grisham Street Offices

António Horta-Osório, Lloyds chief executive, says the recovery will be long and difficult

There are signs of growth in the western world – and by extension brighter prospects for many of the world’s biggest banks.

But the outlook for recovery among those institutions is increasingly dictated by regulation.

While even hardened bankers admit that capital and liquidity levels in the banking system, with the benefit of hindsight, were too low in the run-up to the financial crisis, there are widespread concerns that the higher bars for capital and funding levels will continue to be raised over the coming years, crimping the recovery.

At the same time, bankers complain of a lynch-mob mentality among regulators keen to punish the mistakes of the past, but in doing so undermining efforts to reinvent a cleaned-up, more robust banking sector.

The question for many in the industry, though, is whether the power of an economic recovery can override those legacy issues and make banks sufficiently profitable to be attractive investments.

Despite the farrago over the US budget, there is a widespread sense of optimism that the fundamentals of the American economy are good. Germany’s strong recent performance has been boosted by chancellor Angela Merkel’s election triumph. And in the UK, faith in an economic rebound has taken hold over the past few months.

Underpinning all that – as the oil for the corporate engines of global growth – are the banks.

Lloyds, the most obvious proxy for the recovering UK economy, has seen its share price double over the past 12 months. In part that has been the reward for Lloyds’ clean-up of legacy problems. But the bank is also benefiting from growing optimism about the British macroeconomic picture.

“There are still some big risks on the horizon,” says António Horta-Osório, chief executive. “But the central scenario has to be for a rebound. It will not be a huge recovery: it will be long and difficult. But it will be a recovery.”

Even lenders with developing markets exposure remain upbeat, despite the shock many sustained when the US Federal Reserve signalled a retreat from quantitative easing and the cheap dollar funding it has led to – a move that now seems in abeyance. “Emerging markets might have slowed down a bit,” says Peter Sands, chief executive of Standard Chartered. “But most of these countries are still growing at rates that far outstrip the global average.”

Five years on from the height of the financial crisis, the world’s biggest banks look in far better shape to support their customers, in emerging and developed markets alike.

More solidly capitalised, thanks to pressure from regulators, and with a renewed rhetoric focused on customers – rather than on making money for money’s sake – banks are keen to draw a line under the mistakes of the past.

Emerging markets might have slowed down a bit but most of these countries are still growing at rates that far outstrip the global average

- Peter Sands, chief executive of Standard Chartered

But executives admit that many challenges remain. Chief among them is the relentless flow of bad news from so-called “legacy” abuses, such as Libor interest-rate manipulation, which only emerged years after the boomtime excesses ended.

The Libor affair, which has already seen four financial institutions pay a combined $2.5bn in regulatory fines, looks set to hit another clutch of banks over the next year or two.

Mis-selling scandals have multiplied, particularly in the UK, and there will be plenty more scope for crackdowns by conduct regulators. It is a pattern that Bill Michael, head of financial services at KPMG UK, calls “a mission of retribution”. No matter how cleaned-up the sector’s standards are now, the lax attitudes that informed banks’ boomtime behaviour are coming back to haunt them.

“In the first couple of years after the crisis, it was prudential regulators that held sway,” says one bank chief executive, pointing to initiatives to boost banks’ capital adequacy ratios and liquid asset buffers. “Now, though, the focus has turned to conduct.”

Standard Chartered has been fined for abusing sanctions, HSBC for money laundering and a string of banks, led by Bank of America, have had issues with mortgage mis-selling. JPMorgan has been accused of a list of offences, with Jamie Dimon, its chairman and chief executive, coming under attack from the regulators he once chastised for their hardline rulemaking.

It may take some time before that apparent appetite for revenge is sated. But there is still a round of more fundamental bank reforms to come, which may in turn have ramifications for banks’ ability to support the “real” economy.

In the US, the various provisions of the Dodd-Frank reforms, the largest overhaul of US financial regulation since the 1930s, are gradually being implemented. In the UK, legislation is in train to implement the so-called Vickers reforms, including the central provision that banks’ retail banking operations should be insulated from riskier investment banking activities.

This article is part of a Special Report series

Mastering Growth

European banks still face the biggest obvious hurdle, as the EU ushers in a so-called banking union across the eurozone. To prepare for its new status as chief eurozone banking regulator a year from now, the European Central Bank is set to undertake an asset quality review across the region’s top 130 banks over the next six months.

The process, to be followed by a pan-EU stress test, could lead to the disclosure of some large capital holes. In some ways, it threatens to be another lengthy distraction from banks’ core business of lending.

But optimists believe the process should restore investor faith in the integrity of European banks’ balance sheets, lowering their cost of funding. If the plan works, even the most troubled parts of the eurozone periphery should find banks rediscovering their raison d'être, and greasing the wheels of economic recovery once more.

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