Market consensus tells us the banking sector remains a risky place for investors to put their money. After all, the prevailing wisdom runs, banks are cyclical, poorly capitalised and in lousy shape for the next downturn, as and when it comes. Of course, as contrarian investors, we believe market consensus and prevailing wisdom primarily exist to be challenged – so here goes.
The most recent major exhibit in the case of Market v Banks, which has been pretty much ongoing since the crash of 2008/09, is the outcome of the 2016 Bank of England ‘stress-tests’ published at the end of last year. Royal Bank of Scotland (RBS) attracted most of the negative headlines as the high street bank least prepared for another financial crisis, with Barclays and Standard Chartered also found wanting to a lesser extent.
Most investors will be aware the UK central bank’s now annual stress-tests are designed to assess the financial strength and resilience of the country’s major lenders. Here on The Value Perspective, however, we suspect fewer will know exactly the sort of ‘doomsday scenario’, against which RBS – still almost three-quarters owned by the government following its 2008 bail-out – came up short.
The FT’s annual survey of economists published this week may have found a majority of financial forecasters pessimistic about the UK’s outlook but it is unlikely too many are pencilling in the sort of numbers in the 2016 stress-tests – that UK GDP falls 4.3%, UK unemployment almost doubles to 9.5%, UK house prices fall 31%, oil drops to $20 (£16.23) a barrel, US and eurozone GDP both fall 3% and China enters recession.
Oh – and global GDP falls to -2%. Now, we would not presume to tell the headline writers how to do their job but is not the more astonishing story here that most of the UK’s major lenders were actually able to pass such a test? And the reason they did is because, as we have touched upon in articles such as Robust Bank Story and Sneaking up, banking is one of the few sectors to have been de-risking continuously since the last downturn.
Clearly it is quite right the UK’s major banks are held to account – they are systematically important to the country’s economy and, in addition to RBS, almost 10% of Lloyds remains owned by the taxpayer. Even so, when you look at what they were put through, it is pretty extraordinary – and, even then, RBS only failed once when extra level of onerous implications, including potential litigation, were added into the mix.
Now, compared with the banks, most UK businesses de-risked for much shorter periods before deciding they were in strong enough financial positions to loosen the reins and then, over the last five or six years, make hay as ‘survivors’ of the financial crisis. Which begs a very interesting question – how would other industries fare if the same sort of appalling economic scenario analysis the banks have just faced were applied to them?
Here on The Value Perspective, we suspect such an exercise would be fascinating – albeit in a fairly grim, can’t-take-your-eyes-off-it sort of a way – with, in all likelihood, a very high percentage of business failing. Certainly, we would argue, such a swift deterioration in the macroeconomic environment would be disastrous for, say, housebuilders, high-street retailers and industrial businesses.
So, if you were so minded – and clearly the media and the wider market are not – you could come to a wholly different conclusion on the latest Bank of England stress-testing: that banks are looking extraordinarily robust in the face of some pretty apocalyptic, macroeconomic scenario analysis and it is perhaps your other investments, which on average have de-risked to a much lesser extent, you should be looking at more closely.
- Sign up: The Value Perspective Newsletter
Important Information: The views and opinions contained herein are those of Nick Kirrage Fund Manager, and may not necessarily represent views expressed or reflected in otherSchroders communications, strategies or funds. The sectors and securities shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. The opinions in this document include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. Issued by Schroder Investment Management Limited, 31 Gresham Street, London EC2V 7QA. Registration No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.