Banks facing array of challenges including risk perception following financial crisis, borrowing costs, investor scepticism and falling share prices.

Jaime Caruana, general manager of the Bank for International Settlements (BIS), has said that regulatory reforms alone cannot explain the challenges facing the banking sector. Rather, banks face an array of challenges.

Regulation not to blame for banking sector weaknesses

Caruana said: “To listen to some commentators, one would come away with the impression that the current problems weighing on the banking sector would disappear if only we dialled back the post-crisis efforts to strengthen regulation.”

He noted that the capital markets reflect some of the challenges that banks face as borrowers, also pointing to “the subdued equity valuation of banks, the breakdown of covered interest parity and lessons from the "Great Deleveraging" episode of 2008”, as being some of the challenges that banks are having to address.

Speaking in London yesterday, he pointed out that market pressure, not just regulation, is playing an important role in the tendency of banks to move to better capital, as the “crisis experience has also sharpened the risk perception of banks, bank creditors and equity market investors”.

Investor scepticism driving down share prices

He pointed out that, although there is considerable variation across regions in leverage and asset holdings, most banks' capital significantly exceeds the new capital requirements. But investor scepticism has been driving down share prices and penalising banks when they come to borrow in wholesale markets.

He added: “Many banks also shun the option of reinvesting profits in favour of buying back shares and paying out high dividends, with average dividend yields for major bank stocks of around 5 per cent. Repairing balance sheets and increasing capital through retained earnings and lower dividend payouts could help to mitigate investor scepticism.”

According to the BIS, a 1 percentage point increase in the equity-to-total-assets ratio of a bank could allow it to pay about 4 basis points less to borrow funds, and to increase lending to households and companies.

Complex problems plague banking

Caruana concluded: “My arguments suggest that the diagnosis of what is ailing the banking sector is more complex. While regulation is one element of the business environment that banks take into account in their capital allocation decisions, the underlying challenges to banking in recent times seem to be more deeply rooted in low profitability and unnecessarily costly funding. Repairing balance sheets and increasing capital through greater retention of profit as retained earnings would mitigate many of the problems facing the banking sector. That being said, we will of course continue to monitor the effects of regulation on banks."

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CTMfile take: Jaime Caruana's speech could be read as a rebuffal of the criticism of bank regulations, expressed by many in the banking industry following the election win of Donald Trump in the US last week. While the Dodd-Frank Act has come in for severe criticism and is likely to be repealed (at least in part) next year, Caruana specifically says that the causes of perceived weaknesses in the banking sector are far more complex and varied than any one aspect of regulation alone.