With some noteworthy exceptions, the banking and lending industry has generally rebounded to a healthier condition as of 2010-11 after suffering intensely from late 2007 through much of 2009 during the Great Recession. However, many problems remain unsolved in the financial industry. In October 2010, the International Monetary Fund (IMF) warned of persistent risks in the banking system due to high levels of government debt in mature economies, slow economic growth in many nations, and other significant, difficult to solve problems.  Hundreds of banks failed in the U.S. during 2010 and 2011. In the U.K., major banking firms such as HSBC and RBS remain largely owned by the national government after being bailed out at substantial cost during the financial bust. More recently, the French-Belgian bank Dexia received a new government bailout in the fall of 2011, after being rescued earlier during the financial crisis.

There clearly remains daunting global risk within the banking industry, in particular the risks to banks holding bonds issued by deeply indebted European nations including Italy, Spain and Greece. Banks around the world are subject to immense potential losses from such bonds, whether they hold the bonds directly or they are parties to derivatives, credit swaps, guarantees or financial transactions partly reliant upon the stability of these bonds.

A complete turnaround of the world’s economy and a rebound of the banking industry will take a long and trying time. Today, consumers in many nations have become much more reluctant to go into debt. This will have deep effects on the lending industry and on the pace of economic growth. Consumers in America are buying less of everything than they did during the last boom, which ended in 2007, and they are paying down debts in general as they “deleverage.”

Banking has become a globalized industry in recent decades, like most other sectors. The globalization of the banking industry was fueled by four factors:  1) the availability of global electronic networks for distribution of funds and real-time management information; 2) the easing of local restrictions on ownership by foreign entities; 3) the opportunity to serve the needs of multinational corporations; and 4) the increasing attractiveness, from a banker’s point of view, of business assets and rising household wealth in emerging economies.  New business opportunities were sought out globally by major banks, especially in such booming markets as China. U.S. and European banks particularly took ownership in Chinese banks. Elsewhere, Spanish banks acquired banking firms in South America, Mexico, Puerto Rico and the United States (particularly in Hispanic markets within the U.S.). German and Italian banks merged to form European banking giants.

Regulation: New regulations are about to put banks under pressure, making it more difficult to operate and more difficult to earn profits. The EU has established stringent new rules on banks. In October 2011, major European nations were so concerned about the exposure of their banks to potential losses on bonds issued by highly indebted European nations that leaders in Germany and France were recommending that Tier-1 bank capital requirements be raised to a very high 9% of assets by 2013. (Tier-1 capital is a ratio of equity capital plus stated bank reserves, to assets, and is a commonly used measure of a bank’s core financial stability.)

Meanwhile, the global committee known as the Basel Committee on Banking Supervision (BCBS) continues to monitor the health of the banking system and issue recommendations for minimum bank capital and risk management. The biggest upcoming changes faced by banks that plan to comply with the latest round of recommendations, the “Basel III” accords, will be in raising sufficient capital. The Tier-1 capital requirement will increase to 10.5% by 2019. (In contrast, the massive UK bank RBS had only about 3.5% of Tier-1 capital when the Great Financial Crisis began, and the bank promptly failed. U.S. banks endured losses equal to about 7% of assets during the recent crisis.) The intent is to make it much less likely that massive bank failures will be faced in the future, even during a major financial crisis.

While this may be desirable from a stability point of view, it places significant constraints on banks, as the result will be that they earn a lower profit ratio on assets, and they will likely be required to sell large amounts of new stock, thus diluting the positions of existing stockholders.  (An alternative way to raise capital would be to sell large amounts of assets.)  Compliance with Basel accords is recommended to the governments and regulatory authorities where global banks are based, including the U.S. Nations may choose whether and to what extent to comply on a voluntary basis. In order to comply with the recommended 2019 standard, U.S. and EU banks would need to raise more than $2 trillion in new capital.

Many banks are in much better financial condition than they were in 2008-09, as they have been raising their equity capital levels in recent months, getting a start on meeting future requirements. For example, as of mid-2011, U.S. banks had increased their total equity capital by 20%, or $264 billion, since the end of 2008. This gives them a much greater cushion against potential losses. During that time, American banks also vastly increased their amount of cash on hand, to about $1.8 trillion.
View More