It’s been a great couple of weeks for the banking industry. Admittedly, this is coming off a low base, but after a year in which banks went bust, begging bowls were out, and bankers were pilloried for greed and rapaciousness, there were at least some signs of health returning to the financial system.
If you were feeling optimistic, you might even be inclined to call them ‘green shoots’. In the US, Goldman Sachs posted earnings of $1.81bn last week, besting even the most optimistic analysts’ forecasts. The old Wall Street rule that after a nuclear holocaust there would be only three things left alive – cockroaches, Keith Richards and Goldman Sachs – appeared to be coming true again. Even the worst financial carnage in a generation turned into little more than a blip for the firm.
And it was far from alone. The banks that survived the carnage looked to be clawing their way back to health. Wells Fargo last week posted record earnings for the period, as did JPMorgan Chase. Citigroup, perhaps the most bombed out of the major US banks, managed to end five consecutive quarters of losses by posting a profit of $1.6bn.
There are similar signs in Britain. We’re not yet seeing big bounce-backs in profits. But the share prices of our main banks are starting to anticipate better news ahead. Take Lloyds: from a low of 33p back in January, the shares have broken back through 100p. The price jumped by a third last week alone.
Or Barclays. In March the bank said it had made a “strong start” to the year, and in February it posted a 49% increase in profit for the second half of 2008. The sale of its iShares business has boosted its capital position and the shares have started to reflect that. From a low of 47p they are back above 200p. Even Royal Bank of Scotland, now majority-owned by the British taxpayer, is twitching back into life: from a low of 10p the shares are above 30p. It’s a long way from recovery, but at least the corpse has been dragged out of the morgue.
Of course, fund managers have been seizing on any good news they can find. Everyone knew, even at the start of this year, that some kind of banking system would emerge from the crisis. Eventually it would be a profitable industry once more. So at some point, there was always going to be a massive rebound in burnt-out share prices. Fund managers don’t want to miss out on that, and they are making sure that they are long on the shares well before it happens.
There’s no doubt there are positive signs. The worst of the credit crunch has passed. No more banks are likely to go bust, not big ones anyway. And there are reasons to think that profits may grow from here. First, house prices steadying in the US and UK will stem losses from subprime lending and from a lot of commercial loans. Competition has been reduced, as anyone looking for a mortgage or a credit card will have noticed, which means fatter margins – always good for profits.
But don’t be fooled into thinking that we’re heading back to the good old days for bankers. Banking around the world remains deeply troubled, and it will still be a very long time before it starts returning to a healthy level of profitability again. There are three big issues hanging over the industry.
One, there is still far too much capacity – the only reason competition has lessened is because of a shortage of funds. Banking looks set to become the auto or airline industry of the next decade. There are too many players making very similar products; but just as governments wouldn’t let their flag-carrier airlines go bust and are reluctant to let their car manufacturers go under, so they won’t let their banks go bust either. They will stagger on, overstaffed and barely profitable, until finally someone puts them out of their misery. Eventually there will be four or five global mega-banks, and a host of niche players – but it will be a long time before we get there.
Two, banking is about to become zealously micro-regulated. There are already plenty of signs of that. In the US and Europe, and even offshore centres, financial supervisors are busy devising new rules and regulations. There will be caps on pay. There will be limits on lending. And there will be a clampdown on innovation. You’ve probably got more chance of getting a new type of cigarette advertised on children’s TV than you have of launching a clever new financial product right now.
Three, the best people are about to quit the industry. For a generation, banking attracted the most hard-working, ambitious, creative talent on the planet. They then devoted much of that brainpower to blowing the system up. Still, it made the industry dynamic. But a low-growth, micro-regulated industry isn’t going to attract anything but clock-watchers and pen-pushers – hardly a recipe for growth.
The banks will stabilise at some point. We may even have hit the bottom in January and started the bounce back. But there won’t be another boom in finance or banking – that will be the dullest of dull industries for a generation or more.