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Strange Days in Global Banking

 Like many investors, I’ve been in almost complete disbelief over the extraordinary sell off in global bank stocks recently.

In the last week, banks on both sides of the pond have sold off. U.S. banks such as Bank of America are down 27% this year, while Goldman Sachs is off 18%. And European banks have fared worse, with the Euro STOXX bank index plummeting 24%, despite a big rebound during the middle of the week, according to the report.

The reason for these drops given by financial news channel pundits and even some bankers make little sense. If half of them are true, we’re in deep trouble, because they point to an imminent global economic meltdown.

Fortunately, when you cut through the hysteria, no evidence yet suggests the world’s banking system about to collapse.

The World Bank and the IMF have repeatedly stressed that although global growth is slowing, there is growth. And if we learned one thing from the 2008 global financial crisis, it’s that governments’ central banks will do whatever is needed to protect the global banking system.

And though central banks have less dry power to fight a crisis given what has been spent, they do still have significant arsenal at their disposal (the power to create money from thin air!) to fight another financial collapse if need be.

The whole point of the trillions upon trillions of stimulus dollars that have been spent since 2008 was mainly to recapitalize the world’s banking system and make it safer; while at the same time there have been significant regulatory efforts around the world to force banks to keep a larger cushion of capital reserves in the event of a crisis.

Since 2008 a yearly ritual for bank analysts has been to review the so-called “stress tests” by the Federal Reserve and the European Central Bank that are trotted out annually to alert investors to the conditions of the banking system and its ability to withstand a crisis.

Finally, it strains credibility that any nation on this planet would allow its banks to collapse, as it would be tantamount to thermonuclear blast wiping out its economy. It is with this perspective that I have found it difficult to understand what has been driving the selloff in bank stocks, arguments such as;        

  • Banks sold off because of bad loans to the oil and gas industry. Bank analysts have already established that the big banks have at best between 1% to 6% exposure to the oil and gas industry. As an FBR investment bank analyst said, “That’s not going to kill them. This is not like 2006 or 2007.”
  • Banks sold off because of the prospect of negative interest rates. Given central banks focus on bank’s financial health, it’s debatable if negative rates would be allowed to severely impede bank profitability. And negative rates are a short-term stimulus measure designed to improve the economy, so it would not affect the long-term value of bank stocks.       
  • Banks are not profitable enough. By the standards of before the 2008 financial crisis, banks are less profitable, true. But these days banks are also larger, less risky and better capitalized, generally speaking.Today there is less return, but there is also less risk.  
  • The European Banks have not reformed as much as their American counterparts. It’s true that European banks are behind the curve in bank reforms, but they have been reforming. There is also a valid concern that negative rates in Europe could hurt profits. But again, with Europe’s “whatever it takes” stimulus program, it’s hard to envision a region-wide collapse.

But there is one argument that I do agree with.

  • Central banks around the world haven’t done enough. I have argued for more than three years that central banks stimulus, if ineffective, could lead to global deflation. There is a valid concern that the collapse of asset markets around the world could eventually impede banks. But the bank selloff would only be valid if one believed the central banks around the world would not do everything in their power to support the global banking system, or could not. That’s a prospect which sends chills down my spine, as it would mean a global depression. But to date, there is not a bit of evidence supporting this argument.     

So there hasn’t been any indication of an imminent meltdown in the global banking system, which raises questions about the validity of the bank selloff.  I don’t believe the reasons for the bank selloff have truly come to light, and it’s possible that when the dust clears we’ll find no substantial reason beyond unwarranted fears.

In any case, we will continue to watch the sector closely and give advice as reliable information comes to light.   

In the subscriber section, we stress-tested the strength and wherewithal of our bank holdings’ balance sheets and fundamentals in the event of further market declines and financial turmoil.

 


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