EU banks turning Japanese, analysts warn

Posted on September 6, 2016

ECB announces surprise rate cut to historic low to spur growth...epa04383668 (FILE) A file photo dated 07 August 2014 showing a over-sized barbed wire, part of an installation, seen in front of the European Central Bank (ECB) in Frankfurt Main, Germany. The European Central Bank (ECB) announced surprise interest rates cuts on 04 September 2014 as it steps up its efforts to spur economic growth in the eurozone and to fight the threat of deflation. The Frankfurt-based ECB said it had trimmed its benchmark refinancing rate for the second time in three months, lowering to a historic low of 0.05 per cent. The bank also lowered its deposit rate, which is the rate charged for banks depositing funds at the ECB, deeper into negative territory, cutting it by 10 basis points to minus 0.2 per cent. The move sent the euro down to 1.3 dollars, while shares climbed on markets across Europe. EPA/BORIS ROESSLER©EPA

European banks now have more in common with low-returning Japanese peers than with the Wall Street titans whose returns they covet, researchers at JPMorgan have warned — and they suggest this performance is unlikely to improve.

In recent years, European banks valuations have lagged behind those of their US rivals, as investors looked more favourably on Wall Street’s rapid restructuring after the financial crisis, and the country’s stronger economy.

    However, in a new research note, JPMorgan’s European banks research team have claimed the divergence in performance is now permanent, with Europe’s institutions joining a group of post-crisis low-return lenders along with the Japanese.

    Japan’s banks have struggled to recover from a financial crisis that began for them in the 1990s, after a property price bubble burst and triggered an unprecedented $700bn in credit losses.

    Twenty years on, despite the best efforts of policymakers to boost the system, Japanese banks collectively trade at little more than 8 times their forecast 2017 earnings and about 0.5 times their book value.

    Similarly, Europe’s banks — still in recovery mode after the eurozone crisis — trade at 10 times 2017 earnings and roughly 0.8 times their book value.

    By contrast, US banks, as measured by the MSCI index, trade at 11 times earnings and 1.0 times their book value.

    JPMorgan’s analysts found that central bank moves to flood the system with cheap money, through quantitative easing, have proved equally ineffective in Europe and Japan, with banks in both regions failing to use the cash to expand their loan books.

    “We would expect that the valuation (of the European and Japanese banks) will converge in an ongoing QE (quantitative easing) environment and negative rates,” said Kian Abouhossein, head of JPMorgan’s European banks research team.

    “(The) secondary longer term effect of ongoing QE has also resulted in revenue pressure for European banks, similar to what we have seen in Japan,” the JPMorgan team added, pointing to the fall in net interest margins — the difference between the rate a bank lends and borrows at — in both regions as interest rates fell.

    Mr Abouhossein said that, if anything, European banks were “behind the curve” relative to Japanese rivals because they “haven’t done any of the cost-cutting which Japanese banks have done” or carried out the necessary “balance sheet clean up”.

    Japanese banks were forced to fully recognise their non-performing loans (NPLs) in 1999-2001 and offload a prescribed percentage of them over time. To absorb the resultant losses, the banks were also recapitalised.

    But Mr Abouhossein pointed out that European banks could not take the same approach to NPLs as Japanese banks did, because of EU state-aid rules. He suggested European policymakers’ best chance of boosting the region’s banks was “forcing M&A and forcing dilution of shareholders, by cleaning up the system”.

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