Downside Risks In Banks Could Shift Investors’ Focus

The benefits of a rising rate environment, tax overhaul and an expected ease in regulation have helped U.S. banks gain significantly over the past six months, but there are some downside risks that could shift investors’ focus from the industry.

Primarily, the muted earnings growth that the industry has been witnessing for the last few quarters could raise investors’ concerns and tarnish the optimism over the benefits from policy changes and reforms.

Also, investors’ enthusiasm may wane if the actual benefits don’t meet investors’ expectations or take too long to come.

While there is no indication of disruption in the interest rates moving higher, the yield curve is yet to reach a state where a continued steepening can be predicted. In fact, many forecasters expect the term spread — the difference between long-term and short-term interest rates —to shrink. This could spell trouble for banks.

While rolling back tough post-financial-crisis banking regulations is expected to benefit small and mid-size lenders, the benefits may fail to meet investors’ expectations.

Moreover, softer regulations might benefit banks’ earning mostly from domestic operations. However, larger banks with significant international exposure might lose out on competitiveness due to ever-increasing international regulatory standards. Further, meeting international standards will restrict them from generating domestic revenues.

Though it is too early to make any negative assessment of the likely regulatory overhaul, easier lending standards and lesser regulatory restrictions could increase credit costs for banks, similar to what the industry witnessed just before the recession.

Moreover, there are a number of fundamental challenges that might hold banks back from growing steadily.

Expense reduction was the key measure that helped banks stay afloat for long. But it may not be a major support going forward, as banks have already cut the majority of unnecessary expenses.