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Industry Outlook

Most foreign banks are still reeling under the impact of the global economic slowdown. In the developed nations, persistently low interest rates and subdued loan growth have been taking a heavy toll on banks. Coming to emerging markets, banks are primarily being hurt by corporates staying away from loans due to higher borrowing costs and a significant outflow of capital from their economies.

Moreover, recovery prospects of foreign banks appear bleak as global economic growth may slacken further. The latest global growth projection by the World Bank indicates a derailed recovery ahead. In Jun 2016, the bank revised down the growth forecast by 0.5 percentage points to 2.4% for this year and 0.3 percentage points to 2.8% for 2017.

Major downward revisions in growth forecasts were made for commodity exporting economies such as Brazil, Russia, Nigeria and Angola due to a downswing in commodity prices, weakening currencies and higher borrowing costs.

Japan’s growth forecast for this year was also cut by 0.1 percentage point to 0.5% on concerns that its negative-rate environment will fail to boost the economy.

However, China, the second largest economy of the world, has not seen a forecast revision by the World Bank. China is still expected to grow 6.7% with the help of its stimulus.

Further, the World Bank economists are concerned about the Federal Reserve’s faster-than-expected actions in raising rates causing a huge increase in borrowing costs. This might dampen growth in economies across the globe.

Dark Cloud Over Banks in Key Nations

The major European banks including Barclays (BCS - Analyst Report) , Deutsche Bank (DB - Analyst Report) and Credit Suisse (CS - Snapshot Report) have lost significant value over the past year due to a dearth of business following negative rates and economic woes. The negative rates are forcing them to lend money to corporates and individuals, but this is not helping them in generating decent returns.

Moreover, the U.K. referendum to exit the European Union heightened their risks. Along with Brexit-driven uncertainties, bad assets on balance sheets and an unfavorable rate environment will hinder European banks from showing signs of improvement any time soon.

The prospects of the banks in Japan remained uncertain with the central bank leaving the interest rate unchanged at negative 0.1% at its Sep 2016 meeting. Though the central bank will introduce “yield-curve control” as part of itsmajor policy overhaul to fight deflation, it is unlikely to benefit the banking system in the nation.

Further, in Jun 2016, Fitch Ratings has revised the rating outlooks for Japan’s mega banks including Mitsubishi UFJ Financial Group, Inc. (MTU - Analyst Report) , Nomura Holdings, Inc. (NMR - Snapshot Report) , Sumitomo Mitsui Financial Group, Inc. (SMFG - Snapshot Report) and Mizuho Financial Group, Inc. (MFG) to “negative” from “stable.”

After a number of rate cuts last year in an effort to stimulate the economy, the benchmark rate in China currently stands at 4.35%, which is not unfavorable for its banks. However, the nation’s banks may not get any further support on the rate front as the central bank may not be able to raise rates any time soon. On the other hand, the economy’s credit vulnerability could be dangerous for its banking system.

Prospects Look Worse for Emerging Market Banks 

Banks in emerging markets will continue to suffer as their economies are witnessing huge capital outflow. Further, an increase in interest rates in the U.S. will lead to a capital flight from these markets. As money from these economies move to the U.S. for the benefit of higher rates, matters will be even worse for these economies and their banks. This would dry up the liquidity of banks in these regions.

Further, the U.S. rate hike will make borrowing costlier and a strengthening dollar will make loan repayment expensive for these economies.

Foreign Banks Vulnerable to Weak Macro Backdrop

Growth driven by low oil prices will definitely support foreign banks with business gains. But a low interest rate environment as a result of loose monetary policy in the developed economies will continue to mar the rate-sensitive portion of their revenues.

On the other hand, any action to lower interest rates in emerging markets that have a tight monetary policy and high inflation (like Brazil) could aggravate inflation issues. This, in turn, would take a toll on their banks.

Overall, the weakness in the global financial system is likely to keep the backdrop cluttered for foreign banks.
Business Realignment May Fall Short in Keeping Banks Afloat

Foreign banks keep repositioning business fundamentals to protect themselves from further crises. Defensive actions like limiting expenses by contracting operations and retrenching workforce are still in place, and the focus on noninterest income is extending. But sluggish business activity due to economic disorder, margin compression and slothful loan growth remain serious dampeners.

Capital efficiency remains the key to survival, and most foreign banks have been strengthening their capital ratios by selling non-core assets for quite some time. Further, banks will continue to improve solvency and balance sheet liquidity as they move closer to comply with the Basel III requirements.  While this will make their businesses safer, growth prospects are dull with thinning sources of income.

Immense Pressure on Revenues

The interest rate environment in developed nations (except the U.S.) is not expected to revive any time soon. Naturally, interest-sensitive revenues for banks in these regions are likely remain under pressure. At the same time, their non-interest revenue sources will be limited by regulatory restrictions.

Banks in consumption-driven economies, however, may not be significantly challenged by interest income due to a not-too-low interest rate environment which is needed to keep inflation at check. However, these banks will have no respite from the nagging non-interest revenue challenges. Further, the expected capital outflows from these economies with rising interest rates in the U.S. will add to their woes. Also, intense competition from domestic and foreign players will continue to hinder revenue generation.

New Threats to Banks

FinTech Posing Threat to Banks: The emergence of financial technology companies (known as FinTech), which offer an array of financial services through mobile and cloud computing, is a significant threat to banks. Experts predict growth of FinTech to make traditional branch-based banks redundant in the next 10 years.
Cyber-Crime to Increasingly Hurt Banks: As banks are gradually becoming more technology dependent to suit the changing mindset of the new generation with respect to money, the threats of cyber-crime are increasing.

Localization of Banking

Tight regulation is gradually making globalization of banking a thing of the past. Global banks have been curtailing their exposure to certain countries since the financial crisis due to lack of efficiency and reduced profitability following stringent regulation.

Particularly, stricter capital and liquidity requirements, and segregation of business lines based on the needs of respective countries are hurting foreign banking operations in many economies.

Effect of Regulation

The impact of tighter regulations is yet to be fully felt, with many rules pending implementation across jurisdictions. Continued attempts on strict capital standards by regulators worldwide to clip the risk-taking attitude of banks and prevent the recurrence of a global financial crisis will restrain the potential of industry players far and wide.

The final rules (issued on Nov 9, 2015) of the Financial Stability Board, which was created by the Group of 20 nations (G-20) to keep banks’ reckless behavior in check, require 30 global systematically important banks – that the Basel Committee believes are at risk of turning to too big to fail – to maintain a loss-absorbing capacity ratio (capital plus senior debt/total risk-weighted assets) of at least 16% from Jan 1, 2019. The requirement will increase to at least 18% from Jan 1, 2022. It’s quite likely that these banks will have to issue new debt to meet these requirements.      

Further, the full implementation of the Basel III standards – the risk-proof capital standard agreed upon by regulators across the globe – is due in 2019. The primary requirement for banks is to maintain a minimum total capital ratio of 10.5% by 2019. Though the majority of foreign banks have made significant progress in meeting new liquidity rules, they are yet to fully comply with the standards. So the pressure on capital structure will continue for some time and banks will be less flexible in terms of business investments.

Bottom Line

The rate-hike stance of the Fed is posing near-term concerns over funding insufficiency in other economies and their banks will bear the brunt. Moreover, the not-so-effective cost-control measures and limited access to revenue sources will restrict bottom-line improvement of foreign banks in the upcoming quarters.

Of course, cost reduction by job cuts and asset sales have been instrumental keeping foreign banks afloat, but these strategies may no longer be enough. Instead, the aim should be to enhance operational efficiency through fundamental changes in business models.
However, it’s not easy to deal with an unfavorable macro backdrop. So it’s actually time to play defensive and modify products to meet evolving customer preferences.

Foreign Banks to Dump Now

As concerns surrounding the foreign banking space seem to be deepening, it would be prudent to stay away from industry players that have not been able to win analysts’ confidence with their activities. The following stocks have been witnessing downward estimate revisions and thus carry an unfavorable Zacks Rank:

Credit Suisse Group AG: This Zacks Rank #5 (Strong Sell) stock has lost about 40% since the beginning of the year, compared with about 5.8% gain for the S&P 500. The stock’s earnings estimates for the current fiscal year have been revised 4.6% downward over the last 90 days.   

Intesa Sanpaolo S.p.A. (ISNPY - Snapshot Report) : A 36% downward revision in earnings estimates for the current fiscal year over the last 60 days precipitated a Zacks Rank #5 for this stock. The price of this stock has declined over 30% since the beginning of the year.  

Grupo Financiero Santander Mexico, S.A.B. de C.V. (BSMX - Snapshot Report) : This Zacks Rank #4 (Sell) stock has gained just 4% since the beginning of the year. Earnings estimates for the current fiscal year have been revised 4.5% downward over the last 60 days. Also, the company delivered an average negative earnings surprise of 4.8% over the trailing four quarters.  

Investment Opportunities

The industry might not be able to tide over the economic mayhem anytime soon, but this is perhaps the right time for long-term investors to build positions in foreign bank stocks that have the best prospects and look cheap now. Here are a few stocks that have been witnessing positive estimate revisions and carry a Zacks Rank #1 (Strong Buy):

(You can see the complete list of today’s Zacks #1 Rank stocks here.)

Itaú Unibanco Holding S.A. (ITUB - Analyst Report) :The stock has gained over 80% since the beginning of the year. Earnings estimates for the current fiscal year were revised 18.3% upward over the last 60 days. Also, the stock surpassed estimates by an average 16.1% over the trailing four quarters.

Banco Macro S.A. (BMA - Snapshot Report) : The stock has seen 3.1% upward revision in earnings estimates for the current fiscal year over the last 30 days. Also, the company delivered an average positive earnings surprise of 19.8% over the trailing four quarters. The stock has gained over 34% since the beginning of the year.

The Bank of Nova Scotia (BNS - Snapshot Report) : Thestock has gained about 35% since the beginning of the year. It has seen earnings estimates for the current fiscal year revising 5% upward over the last 60 days. The company surpassed earnings estimates in each of the trailing four quarters with an average beat of 3.2%.

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