Confidence remains shaken in banking

The UK banking sector as a whole saw gains of almost 17% in the period between the beginning of the year and late May; however, this hasn’t necessarily been a steady move upwards.

The statement from the US Federal Reserve on 22 May represented a very large pothole that the banking sector, and indeed equity indices, both here in Europe and the US have so far failed to clamber from. The pullback from the highs of 5350 has come to perch at 4560, right on the 38.2% retracement of the rally from May 2012, with price action also keenly supported by the 200-day moving average.

Can we call this a recovery level, something akin to the 6000 metric on the FTSE 100? From a technical perspective, it does seem to offer opportunity for the usual buy-on-the-dip brigade. Yet, fundamentally speaking, are we even close to reforming our banks either here or Europe as a whole?

Reducing risk

Barclays, Co-operative Bank, Nationwide and the two bailed-out banks RBS and Lloyds have been ordered to plug a £27 billion capital shortfall recently identified by the new banking regulator. Some banks have been tasked with reducing risk in order to focus on a key leverage ratio. The internationally agreed standard for the ratio is 3% – allowing banks to have assets worth 33 times their capital – a prudential requirement that is to be achieved by 2019.

We are still dithering over 81% government-owned RBS in whether to follow the Irish route and separate its loan book into good and bad. Even if that is actually done, there is still a hefty chance the ‘good’, or, in other words, performing loans will not necessarily remain that way.

The banking sector is a massive part of the UK economy and forms a significant part of the services sector – which makes up over 70% of the UK GDP. The UK has the largest banking system relative to its national income in the entire world.

Ring-fencing retail operations from investment banking is certainly a positive step in the reform story as it will give depositors priority over uninsured creditors in the event of a bank failure. This should go some way to renewing faith and confidence in a sector which has been beleaguered with PPI mis-selling and Libor manipulation scandals to name but a few. One would also like to think that it will help to sever links thoroughly, reducing the possibility of the taxpayers being left with the brunt of bailing out problematic banks in the future.

Problems still remain

Euro finance ministers continuing to argue over the separation between the sovereign and the banking sector failed to reach any real conclusion last week, and there appears to be a hugely insignificant pot of money intended to recapitalise European banks.

The recently revealed ‘Anglo Tapes’ in Ireland show a culture (perhaps an historical one) that saw no reason to show honesty or transparency when it came to dire financial situations. The Irish bank is now defunct but the revelation will spur a banking enquiry. Given how inter-connected the global banking is, one could expect to see a few more skeletons.

Perhaps things have to get worse before they get better.

Banking sector chart

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