8 years on, has Lehman cut global bank risks?

The Great Financial Crisis still casts a shadow in the industry, eight years on. The fear remains that it might not be the main event, but simply advance warning of something bigger. After two decades of accumulated bank leverage and a few years of irresponsible lending, the remedy has mainly been sticking plasters. Regulation has hit asset managers hardest, but in many cases, failed to deleverage the worst banks.

In the Eurozone, failure to write-off bad debts where sovereign risk is involved condemns the world to low growth and disinflation. While governments were congratulated for a rapid response in 2008 and 2009, more recent policy looks wrong.

The rebound in stockmarkets, and desire of politicians to reassure all that the banks are safe – has downplayed ongoing problems. In 2008 a handful of banks in the US, UK and Eurozone had astonishing levels of leverage; bad loans and derivatives propped up by a sliver of genuine loss absorbing capital. Just as regulatory capital was flattered in the run up to the Crisis with artificial forms of hybrid capital, now we have contingent convertible bonds and questionable deferred tax reserves. The ability of banks to raise equity capital can disappear very quickly. Events this year with Deutsche Bank have shown how little is understood of the new CoCo bonds.

Gradually, the ECB has intermingled its sovereign risk with bank balance sheets. The problems are not just Italian banks and mutuals, but some of the largest banking names even in Germany. To date, bank bail-ins have been in peripheral areas such as Cyprus, but depositors in some more mainstream banks may be at risk. The UK’s Co-op bank is just one example of the sort of problem that continued after Lehman, and has only been dealt with recently. In general, deleveraging in the UK is ahead of that in the Eurozone, albeit far short of action taken in the US.

The years since Lehman have not brought true wisdom about banks. Not just the public, but even sophisticated corporates, seem unable to discriminate between banks on the basis of bail-in risks. And, negative rates are leaving banks struggling to rebuild capital through profit. Investment banking, which could generate prodigious profits in boom times is now dominated by the biggest US banks. European banks are struggling to compete.

The bank sector needs to see genuine stress tests that more robustly question sovereign assets and loan provisioning. Meaningful bank capital buffers are needed. This will likely force more debt write-downs and encourage mergers. Without that, the sector will remain broken as a channel for new lending and economic growth. Deleveraging might slow short term growth, but seems the only way to give public reassurance on the sector. If the Lehman legacy is to be a healthy bank sector globally, more work must be done.

A version of this article was published in Investment Week on September 15 2016

Disclosure: The opinions expressed in this article are my own, and may not represent the views of any firm or entity with which I am affiliated. The information presented in this article has been obtained from sources believed to be reliable, however, I make no representation as to their accuracy or completeness and accepts no liability for loss arising from the use of the material. Articles and information do not represent investment advice. I am a manager of actively invested equity funds. At the time of publication, clients of my employer held long and short positions in bank stocks.

Image credit: CC Attributioon 2.0. This image was originally posted to Flickr by Robert Scoble at http://flickr.com/photos/35034363287@N01/2861707320 Published on behavioural-investing.org September 15 2016