IMF Waves Red Flag on World’s Top Lenders

Photo by IMF

JAKARTA (TheInsiderStories) – The International Monetary Fund has warned that nine of the world’s largest banks, considered systematically critical, may struggle to maintain profitability in an ominous new global economic environment.

According to IMF’s ‘Global Financial Stability Report’, Citigroup Inc, Barclays PLC, Deutsche Bank AG , Societe Generale SA, UniCredit Group SPA, Standard Chartered PLC, Sumitomo Mitsui Financial Group, Mizuho Financial Group and Mitsubishi UFJ Financial Group are all likely to post mediocre results in the next few years.

These nine banks together represent US$47 trillion in assets, accounting for about a third of assets comprising the so-called ‘globally-systematically-important’ banks.

‘About a third of banks by assets may struggle to achieve sustainable profitability, underscoring ongoing challenges and medium-term vulnerabilities,’ the IMF gloomily surmised in its report on Wednesday (11/10).

According to the IMF, the consensus among banking analysts was for an average return on equity of less than 8 per cent by 2019 for each of the nine banks pinpointed. This figure is generally considered a threshold for lenders to maintain profitability and below it they will typically struggle for capital formation.

Banks have displayed a mixed response addressing legacy and capital challenges from the lingering global financial crisis. Responding early has paid off. US bank profitability, for example, has mostly reached levels in line with or exceeding the 8-percent threshold, a conservative estimate of investors’ required returns, and approach management-stated targets for their returns.

European banks’ 2016 profitability, in contrast, was more mixed, with several banks generating low returns, in part because of slower progress in addressing legacy issues. Overall, about half the banks surveyed by asset size remain below an 8 per cent return on equity.

The outlook for sustained profitability is gradually turning more favorable, as legacy issues are more fully addressed, business models improved and a global recovery appears. Business models slowly improve, along with an expected cyclical improvement in net interest margins; these tendencies should bolster their return on assets.

However, even with such a positive diagnosis, analysts expect one-third of bank assets (about US$17 trillion) to generate returns in 2019 below the magic 8 per cent figure. For these banks, profitability has been restrained by structural forces such as high operating costs, low operating efficiency, and highly competitive home markets, exacerbated in several cases by weak information technology systems.

Banks that exhibit both thin capital buffers relative to future regulatory requirements and relatively weak profitability to build those buffers over the next few years are in particular danger.

Some banks continue to grapple with legacy issues, while others, particularly European investment banks, continue to face fundamental problems of defining and executing profitable business models. Japanese banks’ profitability is historically oppressed by an environment of low domestic interest rates.

These banks are scrambling for new markets, seeking continued international expansion to offset compressed domestic profitability; supervisors are alarmed that such expansion perilously raises currency and maturity mismatch risks. The lessons of 2008 seem to be ignored; nothing fundamental has changed to lower systemic risk.

To foster bank profitability in the upcoming year, regulators should have a redoubled focus on risks from weak business models, to ensure that shakier banks can somehow sustain profitability. Another urgent issue is to finalize Basel III, to prop up the financial sector and create a more level international playing field.

Writing by Yosi Winosa, Email: