The investment case for banking in both Europe and North America is not very positive. Low levels of profitability, concerns over risk costs arising from COVID-19 and an interest rate environment that will continue as central banks seek to support an economic recovery all point to unattractive banking returns. This depressing challenge was nicely summarised recently in the Financial Times. Whilst that article paints a slightly more positive picture for banks in North America, the overall conclusion does not provide support for investors returning to the banking sector. The only potential positive is that the very low level of share price relative to book value, especially for European banks, may provide a reason to invest. But the more challenging issue is raised in the article that talks about the “Japanification” of interest rates in Europe – a description that may also fit the US.
But perhaps there is an upside to all this gloom. The financial sector grew substantially relative to the economy in the last several years. This growth and “over-financialization” of the economy is probably not a healthy long term trend. Reducing investments in banks should lead to a reduced size of the banking sector over time. Hopefully that will lead to a focus on the real economy that should also reduce overall financial risk in the system. But it is likely that the transition will come with some pain as the sector re-adjusts to this new reality.
