Shock, horror! Megabanks are risky!

Liseth Galvis-Corfe - 21 June 2018

In a recent column for the Financial Times, Ben McLannahan showed that 16 of the 39 behemoths classified as global systemically important financial institutions (GSIFIs) have suffered share price falls of more than 20 per cent from their peaks, measured in US Dollars. Chief among them, we find Deutsche Bank, Crédit Agricole, Société Générale and Santander (figure 1). US megabanks have underperformed but to a lesser degree.
Does this imply that the world is on the brink of another searing financial crisis? Not exactly. Rather, it smacks of special pleading by banks whose cost of Dollar funding is rising a little faster than they had hoped or expected. Aided and abetted by central bank governors in emerging economies, they have formed a lobby group to accuse the US Federal Reserve of the financial equivalent of war crimes. Their subtext is that the stability of the global financial system can only be secured in a world of dirt-cheap US interest rates and a depreciating US Dollar. Heaven forbid that foreign borrowers discover that they must repay in appreciated Dollars.
A little context is required. In 2008, the official sector – government agencies and central banks – stepped up and stepped in with a massive financial aid package and developed market central banks put their balance sheets at risk to prevent an implosion. In the heat of battle, no schedule was laid down for the withdrawal of this support and for the risks assumed by the official sector to revert to the private sector.  Private sector megabanks and emerging economy governments, who have magnified their US Dollar-funded balance sheets (figure 2), would rather that the global risk transfer to DM central banks were made permanent.
The megabanks that outperformed the S&P500 splendidly between 2002 and 2006, as they levered up their balance sheets, have been reined in by tighter financial regulation and humbled by the Eurozone financial crisis. Excluding Deutsche Bank, current share prices sit comfortably within their respective post-2008 trading ranges.
Pressures on US Dollar funding costs belong to a class of risks that megabanks are uniquely well-equipped to handle, having full access to elite capital markets and a wide range of derivative products. Has the US tilted the playing field since 2008? Absolutely. US regulators have engineered the withdrawal of US banks from the offshore lending game. US fiscal changes (the Tax Cuts and Jobs Act (2017)) have mandated the repatriation of substantial corporate earnings held overseas. The new law reduces the tax on offshore cash from 30 per cent to 15.5 per cent. US monetary policy has been tightened and the Federal Reserve is shrinking its balance sheet. Hence, US Dollar funding costs are appreciably higher for foreign banks yet utterly affordable.  
Finally, US banks are also underperforming. Between February and June 2018, the share prices of JP Morgan, Goldman Sachs and Citigroup have fallen by 7.4 per cent, 15 per cent and 15 per cent, respectively. Their profitability has been impaired by the flattening spread between the 10-year and 2-year US government bond has changed from 101 to 36 basis points between April 2017 and May 2018. Megabanks (and insurance companies) represent the first line of defence in the financial system and the principle providers of risk capital. Shock, horror, megabanks are risky!

Figure 1

Data source: Thomson Reuters Datastream

Figure 2

Data source: Bank for international Settlements


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