‘The central bankers have won,’ a senior City stockbroker said to me this week with an air of resignation. ‘There’s no point fighting them. Investors are doing as they’re told.’ And, wow, how they’re doing as they’re told. Thanks to central bank money-printing, cash is sloshing around the global financial system in desperate search of a decent return. There may still be little sign of a real economic recovery: China has slowed, to add to the misery in the eurozone. Yet the Standard & Poor’s 500 index of US stocks is at an all-time high and the FTSE 100 is within a whisker of breaking above its 14-year peak. Even Greek ten-year government bonds now yield a fraction over 8 per cent, remarkable when one considers that just a year ago, few people were willing to bet the country would at this stage still be in the euro.
UK bank stocks ought to be an ideal way to play this latest mania. After all, British banks have been the ginger-haired stepchildren of the financial world for the past five years. Like other European banks, their shares have rallied over the past year as the euro crisis has eased. Barclays shares have more than doubled since last June when the interest-rate-rigging scandal broke; Royal Bank of Scotland shares are up 70 per cent and Lloyds Banking Group about 30 per cent. But UK banks still tend to be more lowly valued than their European peers. Barclays is valued at just 80 per cent of its book value, or what the accounts say its assets are worth; Royal Bank of Scotland trades at just 30 per cent. The European average is above 100 per cent. With Bank of England governor Sir Mervyn King now claiming to have spotted green shoots, what better time for the government to be contemplating selling bank shares, and the public to be buying?
Not so fast. UK banks remain relatively unloved for a reason. Partly, it’s a question of lingering doubts about their business models. British banks have aggressively restructured themselves since the start of the crisis. RBS has cut its balance sheet by half, shedding £1 billion of loans and other assets. At the same time, it has reduced the amount it borrows from bond markets each year by £300 billion. Lloyds has now shed virtually all its toxic legacy assets. And both banks reported profits in the first three months of this year after years of losses as bad debt charges fell. Yet doubts persist about the strength of their capital positions. RBS and Barclays in particular still look weakly capitalised compared to other major European banks, raising doubts about how soon they will be able to resume paying chunky dividends. And in the current environment, investors crave dividends above all else.
But what has really spooked investors is regulatory risks. As far as the market is concerned, British banks have been living these past five years in a world of endlessly shifting regulatory goalposts, the product of a toxic banker-bashing political environment and a theological crusade by an overzealous central bank whose understanding of banking is detached from economic reality. Banks have been hit by an array of new taxes, constantly evolving rules on bank capital and lingering uncertainty over the final shape of the Vickers reforms, and they have been starved of central bank funding. Even now, Sir Meryvn and his Bank of England colleagues continue to insist the UK banks are concealing a £25 billion capital shortfall, although they have yet to spell out to either banks or the markets where this hole is to be found — an astonishing lack of transparency, one might think, akin to creating a false market. At the same time, the Parliamentary Committee on banking standards is set to propose further draconian reforms of the sector.
For UK bank shares to rally hard from where they are now, one needs to make two assumptions. The first is that Sir Mervyn’s departure in June will mark the end of this regulatory onslaught. That seems a reasonable proposition: incoming governor Mark Carney has a reputation for being more pragmatic and his background in the industry may make him more sympathetic to the real-world challenges faced by banks. Besides, Chancellor George Osborne has taken steps over the past year to clip the wings of the Bank of England, while at the same time setting up new schemes such as Funding for Lending and Help to Buy designed to encourage more bank lending. Even so, the spectre of regulatory dismemberment still hangs over Barclays as it awaits details of proposed ring-fencing of parts of its business in the UK and US. And RBS’s growth continues to be held back by politically driven demands that it cuts back its markets business.
The second assumption is that the central bankers really have won: that the tide of cheap money will lift the economy so that bad debt charges fall away and bank profits start gushing. That is a more questionable assumption. It suggests that ultimately the answer to a debt crisis is more debt; that the UK and world can borrow its way back to health on the back of ultra-low interest rates; and that this time governments, banks and households will have learnt their lesson and will use the proceeds of growth to pay down debt rather than blow up new bubbles. History suggests that is unlikely. But who can afford to bet against the combined might of the world’s central banks?