New criteria for investing in the banking sector?

Financial,accounting,investment advisor consulting with her team

Despite the 2008 financial crisis, many financial scandals continue to cost the sector dearly. The latter is degraded by its incessant expenditure on trials and fines. Since 2008, the entire banking sector has continued to disappoint. Among other things, he was accused of being responsible for market manipulation. The handling of Libor or FX Trading are the best examples of this. The financial sector is also being sued for abusive sales, such as the recent PPI scandal in Britain. But he is accused of many other serious offences, such as violations of tax evasion, anti-money laundering and suspicions against the famous Dark pools.

These scandals reveal two striking conclusions. The first is the persistence of these serious, even illegal, misconduct after the 2008 Subprime crisis and despite the commitment of the regulators that followed. The second is the financial and reputation impact on the entire business. Undoubtedly, the fines and sanctions imposed have been far more significant than the harmful profits generated in the first place. Especially since many banks still have many outstanding errors. Yet already, the banking sector has paid $275 billion since 2008 in fines and regulations. That is $275 billion that could not be paid to shareholders or used for growth. In 2016, Société Générale published a report denouncing an average expenditure of 15% of the stock market capitalisation of the largest banks on costs for serious misconduct. In addition to the fines imposed for these harmful behaviours, several other consequences have been observed in the sector. First, banks must implement additional costs to comply with the new rules applied by the regulations. Secondly, a real lack of confidence in financial activity is developing. The latter then suffers from an erosion of its customer contracts and its relationships with its trading counterparties. Also from the investors’ point of view, this unpredictability, which governs the sector, perfectly explains their fear. Their loss of interest leads to a drop in their stock prices and thus increases the cost of bank capital.

Mark Carney, Chairman of the Financial Stability Board and Governor of the Bank of England (2014) states “This succession of scandals proves that it is now impossible to think that the source of the problems is only a handful of a few isolated cases. A fundamental change is needed in the institutional culture.”

For investors, this requires integrating new non-financial criteria into their investment process. These bad behaviours, which impact banks’ capital, now push investment analyses to integrate a matrix that takes into account the bank’s capital generation and the reforms implemented to prevent any risk of excessive behaviour. The bank’s ability to generate capital effectively allows the bank to absorb possible costs for serious misconduct. This case can easily be seen for American banks, which are better able to pay fines and have performed better than Deutsch Bank, for example. A social and governance cultural reform within the firm allows it to reduce the risk of misconduct.

These two criteria thus reflect the firm’s potential to distribute this strong generation of capital to its shareholders rather than having it spend on customer adjustments or settlements to various regulations. According to the Société Générale report, investors can now consider this matrix as essential to make an investment choice in the banking sector and thus avoid very unpleasant surprises as a shareholder.

Sources :

The culture of British retail banking, UK New City Agenda/Cass Business School Report, 2014.

Culture change in Banking, Société Générale Report, 2016

Marine Brabec


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