Reportedly, second and third quarter was an impressive period of significant improvements for US banks, but still we get to hear some news about the stocks of large banks that declined by more than 20 percent. This is happening since the beginning of the third quarter and four out of every five people are trading below the book value. Do you know why?
Here’s a sneak peak…
While some commentators blame the fear of double dip recession or may be Europe’s sovereign debt crisis, McKinsey Quarterly has tried to draw attention to three additional factors. The undermining issues brought to light by this business journal include the new bank capital requirements initiated under Basel III international-banking regulations, impact of new US banking regulations retorting to financial crisis, Dodd–Frank Act, and continuous deleveraging of customers.
As per the estimates, if these banks continue following the current business model, their average ROE (Return on Equity) is expected to fall from 11% to 7% by the year 2015. Moreover, the investors are also willing to see bank management teams to put forward trustworthy and far reaching plans to fill this gap. This is the current scenario, but what next?
What does the current status imply?
Out of these three factors, Basel III requirement is the most significant, since without justifying actions, they could reduce ROE of some banks by 5%. And that is why, it is being estimated that US banking system will require almost $500 billion in retained earning or may be an absolutely new equity to meet new standards. The second threat is also stepping forward slowly, as an amendment caps fees on payments and there is also a requirement to move many Over-The-Counter (OTC) businesses to clearing houses. This will probably lead to more expensive and complex day to day operations.
Then the next threat is all about unwinding of consumer debt and according to the analysis, when excessive borrowing becomes the principal cause of recession, businesses tend to spend next eight years to restructure their balance sheets. So, there is a very little prospect for the companies to return from those borrowing levels and some may never even return.
Therefore, banks must constrict the most out of all the capital cash especially that they have been neglecting from more than a decade. In fact, linking to risk adjusted capital usage would prove even more helpful in such a scenario.
– Charu Mehta, CRMIT