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IMF's unusual comment on struggling G-SIBs draws mixed response from analysts

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IMF's unusual comment on struggling G-SIBs draws mixed response from analysts

The International Monetary Fund expressed concern in its October Global Financial Stability Report that nine banks, including five European companies, will struggle to deliver sustainable returns in 2019, a warning that comes at a time when European banks are fighting to keep pace with their U.S. and Asian peers.

Most analysts who spoke to S&P Global Market Intelligence agreed with the consensus forecast published by the IMF, which said Italy's UniCredit SpA, Germany's Deutsche Bank AG, France's Société Générale SA, U.K.-headquartered Barclays Plc and Standard Chartered Plc, along with Japan's Sumitomo Mitsui Financial Group Inc., Mizuho Financial Group Inc. and Mitsubishi UFJ Financial Group Inc., and New York-based Citigroup Inc. are unlikely to have a return on equity over 8% by 2019. All nine are designated globally systemic important banks, or G-SIBs, by the Bank for International Settlements.

But one observer said the decision of the Washington-based lender of last resort, which is traditionally impartial, to name nine banks was "odd" because it appeared to open the way to a return to higher-risk activities.

Higher-risk activities

Sam Theodore, managing director for financial institutions at Frankfurt-based rating agency Scope Ratings, said: "It would probably be possible for a large bank to boost profitability by getting back into higher-risk, higher-return activities, which were scaled down when the crisis hit, or by indiscriminately cutting costs by massive branch and back-office closings and thus leaving potentially tens of thousands of people without jobs. It is doubtful that such steps would lead to lower financial stability risk."

The IMF risked being interpreted as encouraging the market behavior which brought about the financial crisis of 2008, Theodore added. "It seems highly unconstructive for an international public organization to single out by name specific banks for the sin of not being profitable enough. Again, nobody, including the IMF, would like to go back to the time when banks were focusing on maximizing short-term profits while neglecting long-term risks. I would assume that by and large bank regulators would agree with this statement."

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However, Peter Dattels, deputy director of the IMF’s Monetary and Capital Markets Department, said the IMF believes that "targets for sustainable profitability can be met without taking undue risks."

"In the report, we point to factors behind low profitability, such as high operating costs, but we do not suggest specific measures such as a reduction in headcount," Dattels said. "We highlight the challenges for some regions and, for example, the need for greater progress in addressing legacy issues [nonperforming loans]. Nowhere in our discussion of G-SIBs do we advocate increasing the riskiness of bank activities."

In the text of the report, the IMF blamed "structural forces such as high operating costs, low efficiency, and highly competitive home markets, exacerbated in several cases by weak information technology systems," for the poor outlook for the nine G-SIBs. It also pointed out that European banks in particular were still grappling with legacy issues, and in some cases were struggling to identify profitable business models. U.K. and continental European banks still have "a long way to go" with restructuring by comparison to their peers in the U.S., the report said, with restructuring charges running to $13 billion in 2016, or 25% of underlying net profits.

It also urged regulators to have "a strong focus on risks from weak business models" to make sure that lagging banks' profits are sustainable, and said that it was important to finalize Basel III "to further strengthen the financial sector and create a more level international playing field."

'A-list celebrities'

Other analysts saw no harm in the IMF's move.

"I guess the whole concept of a G-SIB means that they become a natural topic in any discussion of global financial stability, with [international] agencies [and] regulators probably feeling they do not need to be quite so discreet in comments about them as they would in referring to other private sector financial institutions," said John Raymond, president and senior banks analyst at CreditSights. "They’re now the officially-designated A-list celebrities of the banking world, so have to face the glare of publicity that comes with that status."

Ian Gordon, U.K.-based banks analyst at Investec, agreed with the IMF's comments as far as the British-based banks were concerned:

"What the IMF are saying is not new news. Apart from Lloyds Banking Group Plc, I don't have any of the FTSE 100 banks down as generating a 10% return on tangible equity anytime before 2020. That's been my stock answer for some time, and it remains," he said in an interview, but added that the report was "an acknowledgement that profitability remains weak."

Piers Brown, London-based analyst with Macquarie, said he was wary of reading too much into the IMF's October report, as the negative view of the nine banks in question is based on a consensus forecast. "The IMF is a consensus-following organisation, and this is not their own analysis," he said.