Via Financial Times

Global investment banks risk seeing their annual earnings wiped out by the coronavirus crisis, with European banks more vulnerable than their more profitable US counterparts. 

Even the most optimistic “rapid rebound” scenario, where relative normality is restored in six months or less, could lead to a 100 per cent decline in profits this year, according to a new report co-authored by Oliver Wyman and Morgan Stanley. 

In a more pessimistic model — dubbed “deep global recession” and lasting a year or more — some weaker banks would slump to big losses. In this scenario, credit losses could surge to between $200bn to $300bn, compared with $30bn to $50bn if a rapid rebound unfolds.

While the banking industry has built up robust capital and liquidity buffers since the financial crisis, “returns have never been lower entering a major stress event and banks’ first line of defence is pre-provision profitability,” said Morgan Stanley’s Magdalena Stoklosa, who led the report alongside Oliver Wyman’s James Davis.

“The pressure on earnings could reveal structural weaknesses in some business models [ . . .] the performance gap will be wide,” said Ms Stoklosa. “The biggest single driver of profitability is scale”, which means an increasingly dominant Wall Street — where JPMorgan is the most profitable lender — is likely to use the crisis to take further market share from smaller European lenders.

Germany’s struggling lenders Deutsche Bank and Commerzbank are the worst positioned among big banks, having little or no profits to absorb a wave of loan defaults. Meanwhile Switzerland’s Credit Suisse and UBS are the European players best positioned to cope, largely thanks to their shift away from investment banking towards wealth and asset management.

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Amid the turmoil caused by the lockdowns imposed to contain the pandemic, banks’ resilience is being closely watched. A record number of companies have been forced to seek state support. 

Governments and central banks have unveiled measures to support lenders, including freeing up $500bn in capital by temporarily relaxing regulations and pumping trillions of cheap financing into the system. 

Despite all the help, “we are still talking about an ugly earnings scenario rather than banks dipping below their capital requirements,” said Ms Stoklosa.

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For the past five years, wholesale banks have generated an average return on equity of 9 to 10 per cent, according to the report. In the best-case scenario, that measure of profitability will halve to 4 to 5 per cent between 2020 to 2022 — well below the 10 per cent targeted by investors — with the weakest lenders falling to zero or below. 

The eurozone banking system entered this crisis in a particularly weak state. A European Central Bank study last week showing average returns had fallen to 5.2 per cent in 2019, less than half that of their US peers.

The performance will “intensify calls for significant strategic change, potentially also acting as a catalyst for consolidation among European and tier-2 players,” the report said.

Unlike in the 2008 financial crisis, banks can no longer compensate for plunging profits by slashing billions in costs because fixed regulatory, compliance and IT costs have built up.

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Additionally, “in the midst of a public health emergency, banks are unlikely to pursue cost-cutting through imposing redundancies,” the report said. HSBC has already said it will delay the “vast majority” of redundancies in its restructuring. Some banks may be pushed to sell assets or exit business lines to create breathing room, the report added.

Within investment banking, a slowdown in dealmaking and capital markets is likely to be partially offset by a surge in trading revenue during the initial volatility. Meanwhile transaction banking and securities services will be hit by record-low global interest rates that will eat into their margins.