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Whimper, not a bang

The central issue for global banking this time around is not that a bunch of banks are going to immolate but that they won’t make enough money to attract investors. That would be going out with a whimper not a bang.

“Cause for concern is evident in banks’ performance on two yardsticks: return on equity (ROE), a measure of current profitability, and market-to-book value, a leading indicator of how capital markets value banking,” McKinsey argues.

“Fifty-one per cent of banks operate with an ROE below cost of equity (COE), and 17 per cent are below COE by more than 4 percentage points. In an industry that has high capital requirements and is operating amid low interest rates, creating value for shareholders is structurally challenging.”

Since the financial crisis banks have not been great stewards of shareholder funds in McKinsey’s view: “In fact, the almost $US2.8 trillion of capital that was injected by shareholders and governments into banking over the past 13 years eroded 3 to 4 percentage points of ROE.”

That translates into valuations: “Banks are trading at about 1.0 times book value, versus 3.0 times for all other industries and 1.3 times for financial institutions excluding banks, with 47 per cent of banks trading for less than the equity on their books.”

Yet this is not true for all banks – during the pandemic the financial system as a whole gained about $US1.9 trillion (more than 20 per cent) in market capitalisation, McKinsey says.

The next phase

So the issue comes back to the growing disparity between high and low performers. What are the forces then that will push this disparity?

Competition is intense not just between incumbent financial institutions but from emerging competitors, be they fintech, bigtechs, neo-banks and non-bank financial institutions. This next phase will swing on which organisations can most quickly move to the kind of digitalisation customers want and harness the power of the data they have access to – without damaging the necessary trust their customers demand.

Yet at least these are comprehensible and largely measurable threats.

Climate change, as an existential threat to the planet, is also a clear and present danger to the financial system, on two fronts.

The Reserve Bank of Australia’s (RBA) deputy governor Guy Debelle summed it up in a speech titled “Climate Risks and the Australian Financial System”.

“Climate change is a first-order risk for the financial system. It has a broad-ranging impact on Australia, both in terms of geography and in terms of Australian businesses and households. Most Australian financial institutions now recognise climate as a risk. The assessment of climate risks has evolved considerably over the past five years, but there remains considerable scope for further improvement.”

That’s one front. But the other is the opportunity cost: there is value in investing in those industries and technologies that will address climate change and the financial assets that will support investment in the transition to lower carbon intensity.

According to the International Energy Agency’s World Energy Outlook 2021, investment related to the transition to zero emissions will need to reach $US4 trillion annually by 2030 from around $US1 trillion now. That makes this one of the great financial opportunities in history.

This bank, ANZ, recently held an investor day on its Environmental Sustainability Strategy and the focus was on that opportunity. Chief Executive Shayne Elliott described the transition as “super cycle” that “will drive immense opportunities … in decades to come for both us and our customers”.

ANZ’s position is that it accepts climate change is a financial risk, and a shared challenge for customers, governments and the financial sector. But also an opportunity.

According to Elliott, “the biggest role we can play is through our financing, services and advice – backing customers who have the right plans and commitments in place”.

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