For Immediate Release

Chicago, IL – October 22, 2014 – Today, Zacks Equity Research discusses the Foreign Banks, Deutsche Bank AG (DB-Free Report), HSBC Holdings (HSBC-Free Report), Barclays PLC (BCS-Free Report), Bank of Montreal (BMO-Free Report) and Royal Bank of Scotland (RBS-Free Report).

Industry: Foreign Banks

Link: http://www.zacks.com/commentary/34949/

A prolonged low interest rate environment in developed nations is not expected to reverse anytime soon as central banks of these economies will continue to prioritize growth. This strategy looks sustainable as increasing rates to control inflation is required only for a few emerging economies. These economies have started witnessing a sluggish growth rate, but dominating inflation concerns will force their central banks to keep interest rates higher than in low-inflation economies.

For any economy, low but positive inflation is desirable as it protects the purchasing power of consumers, keeps borrowing costs low, thereby creating a favorable business backdrop.
Given the current condition, banks operating in a low interest rate environment will not be able boost revenue through interest income. At the same time, non-interest revenue sources will be limited by regulatory restrictions.

On the other hand, banks in consumption-driven economies will not face significant challenges related to interest income due to a not-too-low interest rate environment. However, these banks will have no respite from nagging non-interest revenue challenges. Also, high competition from domestic and foreign players, and the downside of loose monetary policy will continue to hinder revenue generation.

What to Expect Down the Road?

Funding insufficiency, not-so-effective cost-control measures, and limited access to revenue sources will keep bottom-line improvement under pressure in the upcoming quarters.

Moreover, the impact of tighter regulations is yet to be fully felt with many rules pending implementation across jurisdictions. Continued attempts by regulators worldwide to agree on strict capital standards and clip the excessive risk-taking attitude of banks and prevent the recurrence of a global financial crisis will restrain the growth potential of some industry participants.

The full implementation of the Basel III standards -- the risk-proof capital standard agreed upon by regulators across the world -- is due in 2018. Though some non-U.S. banks have already started complying with the requirements, many have yet to make headway.

Nonetheless, strict lending limits as well as greater transparency in regulations could strengthen fundamentals of many sector participants. Eventually, these are expected to create a less risky lane for the overall industry.

What Fed Rules for Foreign Banks Mean

The Federal Reserve’s stricter capital rules for foreign banking organizations (FBOs) sizably operating in the U.S. could cripple their balance sheet. According to the new rules, the U.S. operations of foreign banks need to hold risk-based capital, liquidity and leverage similar to their U.S. peers with effect from July 1, 2016.

This will force foreign banks such as Deutsche Bank AG (DB-Free Report), HSBC Holdings (HSBC-Free Report), Barclays PLC (BCS-Free Report), Bank of Montreal (BMO-Free Report) and Royal Bank of Scotland (RBS-Free Report) to transfer costly capital from their home ground to the U.S. So their overall profitability could suffer as they need to spend more on the same business in the U.S.

But for low-margin businesses like repo and securities lending, in particular, transferring capital and liquidity to U.S. operations will not be beneficial for FBOs. Given this concern, some of the foreign banks have already planned to trim their U.S. balance sheets. Others could also follow suit by axing their low-margin U.S. businesses.

Conclusion

Overall, a key determinant for a quick recovery will be the quality of risk analysis and risk awareness in decision making. So, we believe that accumulating larger capital buffers over the cycle and reducing pointless complexity in business will be crucial to the performance of non-U.S. banks.

Also, only cost reduction by job cuts and asset sales should no longer be considered enough. Instead, the aim should be to enhance operational efficiency through fundamental changes in business models. The capital goal of non-U.S. banks should not be restricted to simply obedience to regulatory requirements.

On the other hand, policymakers should primarily pay attention on determining the span of fiscal stimulus, ensuring that it stays until a clear sign of transition from recovery to growth is visible.

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