As the Fed continues to scale back stimulus in the U.S., growth
in the emerging economies lose steam because of liquidity
reduction. But improvements in Europe and China have been able to
offset the negativity, lending a positive sentiment to the
worldwide economy. The non-U.S. banking space is fast catching up
with this progress and has impressed with signs of improvement in
Of course, the improvement varies across locations depending on the
ability to grab opportunities stemming from the wave of worldwide
economic growth. But repositioning of business fundamentals to
withstand any further crisis remains the trend.
Steady growth in non-U.S. banks is stemming from the proactive
steps taken by the central banks of most developed and emerging
economies. But the global financial system is yet to show tidiness
to ensure a steady backdrop for banks.
Policy makers' efforts to avoid another collapse have resulted in
the flurry of banking regulations around the world. This is taking
a toll on banks' top and bottom lines, but the institutions are
chalking out new strategies to counter regulatory burdens and plan
As capital efficiency is the key to survival, most foreign banks
are adopting reconstruction-by-asset-sale strategies to strengthen
capital ratios. While this will make their business safer, growth
prospects don't look impressive with thinning sources of income.
Also, the sector must continue to fight macroeconomic challenges
that limit growth opportunities.
Moreover, a prolonged low interest rate environment is not expected
to reverse any time soon as central banks of most of the countries
will continue to prioritize growth over inflation control. This
strategy is sustainable as inflation is the concern of only a few
Thus, banks operating in a low interest rate environment will not
be able boost revenue through interest income. On the other hand,
non-interest revenue sources will be limited by regulatory
Banks in consumption-driven economies will not, however, face
significant challenges related to interest income due to a
not-too-low interest rate environment. Still-high inflation will
continue to force the central banks of these economies to keep
interest rates higher than the low-inflation economies. However,
non-interest revenue challenges will persist for these banks as
Stringent regulation is a prolonged difficulty in optimization of
business investments for non-U.S. banks. This leaves restructuring
of operating models as the only growth driver. Most of the banks
are resorting to the required measures, but a significant
transformation will happen in its own time.
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 still to be implemented across jurisdictions.
Continued attempts by regulators worldwide to agree on strict
capital standards and clip the risk-taking attitude of banks so as
to 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 are yet to make headway. To
add to the difficulty, the latest changes indicate that banks need
to hold more capital than what the Basel Committee mandated
Nonetheless, strict lending limits as well as greater transparency
in regulations could strengthen the fundamentals of many sector
participants. Eventually, these are expected to create a less risky
lane for the overall industry.
Fed Rules: A New Concern
The Federal Reserve is set to implement stricter capital rules for
foreign banks such as
Deutsche Bank AG
) with sizeable operations in the U.S. According to the new rules,
the U.S. operations of foreign banks need to hold as much capital
as their U.S. peers.
This will force foreign banks to transfer their costly capital from
their home country to the U.S. So their overall profitability could
suffer as they need to spend more for the same business in the U.S.
Eurozone Sustains Recovery
The downside risk of the European economy appears much lesser than
what it was a year ago. The economy showed continuous growth in the
last three quarters following the end of an 18-month recession. It
is believed that growth in the concluding quarter of 2013 was
primarily driven by exports, but a sharp rise in consumer
confidence, expansion of manufacturing output and
faster-than-expected growth in private-sector business activities
confirm the fundamental recovery of the economy.
The stain of Eurozone woes on global banks has faded without doubt.
In fact, this has been translating into strength for some of the
non-U.S. banking giants.
The steps taken by European policymakers have significantly helped
in stabilizing the economy. Primarily, the European Central Bank's
(ECB) long-term refinancing operations have helped in injecting
liquidity into the system. Further, the continent has been
progressing well with respect to setting up a banking union, which
will allow the ECB to intervene directly in banking operations
within the continent.
The banking union will be authorized to supervise large banks in
countries that use the euro. This should help banks to tidy up and
ensure consumer protection in economically weaker countries like
Spain, Italy and Portugal. This will in turn make the banking
activities more transparent and support the continent's economic
Behind Emerging Market Banks
Tapering of stimulus in the U.S. is taking the luster off banks in
emerging markets. Actually, these markets have so long grown on the
back of inflow of infused capital from the U.S. economy. Now, with
liquidity levels drying up, the banking sector in these markets
face the risk of a slowdown.
Moreover, the asset quality trouble is still obvious. But this is
not as severe as the problems that many of the larger banks face in
continental Europe and the United Kingdom - such as toxic
securities and subdued capital raising.
Hopefully, less exposure to property markets and steady interest
income from a not-too-low interest rate environment will help these
banks offset the negatives to some extent.
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
performances 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 be more than just
obeying regulatory requirements.
On the other hand, the primary attention of policymakers should be
on determining the span of fiscal stimulus, ensuring that it
remains until a clear sign of transition from recovery to growth is
Shinhan Financial Group Company Limited
) is the only bank carrying a Zacks Rank #1 (Strong Buy) in our
non-U.S. bank universe. We also recommend banks with a Zacks Rank
#2 (Buy) including
HDFC Bank Ltd.
Lloyds Banking Group plc
The Royal Bank of Scotland Group plc
National Australia Bank Limited
Currently, three banks we dislike with a Zacks Rank #5 (Strong
Australia & New Zealand Banking Group Limited
Grupo Financiero Santander Mexico, S.A.B. de C.V.
Westpac Banking Corporation
We also dislike some stocks in the non-U.S. bank universe with the
Zacks Rank #4 (Sell), including
Banco Santander, S.A.
Bank of Montreal
The Bank of Nova Scotia
ICICI Bank Ltd.
KB Financial Group, Inc.
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