Banks cannot escape a gloomy economic outlook – JulieSimba
Banks cannot escape a gloomy economic outlook

Banks cannot escape a gloomy economic outlook

When they gathered in the graceful Portuguese resort of Sintra last week, the west’s top central bankers were anything but. An awkward Federal Reserve chair Jay Powell bemoaned “how little we understand about inflation”. A dazzled European Central Bank president Christine Lagarde lamented the “massive geopolitical shock” of Russia’s Ukraine invasion. Andrew Bailey, the gaffe-prone Bank of England governor, talked of a baffling “sea change” in the way they work.

Many months after bearish commentators were warning of the stubborn momentum of prices, this finally was the moment when all three central bankers aligned themselves as monetary policy hawks. Controlling inflation, they reminded the world, was their key focus — though you wouldn’t know it, given price rises are now nudging 10 per cent on both sides of the Atlantic.

To give Powell his due, the Fed has been less behind the curve than its peers. It began its hawkish pivot as far back as December. More recently, the Fed has begun raising rates in alarmingly large 0.75 percentage point chunks. This has made it more likely that he will avoid recession through his yearned-for “softish” landing. But at least he is boosting his chances of getting runaway prices under control.

With admirable joined-up thinking, the Fed’s stress test of the US banking system came out a few days ago, with reassuring news that all 34 of the banks tested are in decent health, protected by robust capital cushions. The scenarios for the tests were timely and tough: a decline of nearly 40 per cent in commercial real estate prices, a 55 per cent drop in equity prices, a more stressed corporate debt market and a 10 per cent rate of unemployment.

The Fed didn’t leave it there, either. Within days, it was demonstrating that it is as hawkish on bank capital as it is on interest rate policy. The biggest US banks were told they would in the future have to maintain bigger capital cushions — on average one percentage point bigger — potentially trimming their plans for dividend payouts and share buybacks. All eminently sensible if recession is looming.

Investors in European banks have had less reassurance from their central banks and regulators. True, a number of big European banks were tested as part of the US exercise — but it was only their US arms that were under review, a number of which have artificially high capital cushions. Overall, the European banks did well in the Fed test, though the performance of Credit Suisse, whose stress capital fell the most of all 34 banks in the exercise, and that of HSBC, the second-biggest faller, was hardly comforting — especially given Their more existential battles: Credit Suisse with serial misdemeanours and HSBC with its whole China-meets-the-west business model.

European regulators themselves have not been stress testing their own banks. The European Banking Authority decided last year that it would skip tests in 2022, focusing instead on an exercise to assess banks’ long-term preparedness for climate change. Vital as this is, it does feel oddly out of sync with the short-term financial impact that inflation, recession and asset price collapses will visit on the eurozone’s banks.

The BoE, meanwhile, said in March that the disruption caused by the Ukraine conflict was so significant a management challenge that it didn’t want to add to the burden by running stress tests at the same time, and so postponed them. It promised to provide an update by the end of June. This didn’t happen, though I’m assured there will be an announcement on the topic when the BoE publishes its next financial stability report this week.

Not before time. As Bailey himself has admitted, the UK economy is “weakening rather earlier and somewhat more than others”.

Analysts at Bank of America predict UK GDP growth will slump to 0.4 per cent next year, compared with 1.3 per cent for the eurozone and 1.4 per cent for the US. Recession is likely everywhere, but is surely unavoidable in the UK.

For the banks, many of which still claim to see no evidence of customers falling behind on debt repayments or otherwise getting into trouble, the conclusion must surely be that this is merely the calm before the storm. The discount on European banks versus their American rivals is currently substantial: they trade on a price-to-book value multiple of 0.61, against 1.06 for US banks. In the absence of better intelligence on the stress ahead, that discount can only widen.

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