Bank of England: Investors may need to accept lower bank profits

Global banks such as Citi and Goldman Sachs have reported sharp falls in profits in their latest earnings.


LONDON - Investors have not fully priced in the likelihood that banks will generate lower returns than in the past as they shift to less risky business models, a deputy governor of the Bank of England said on Tuesday.

Major global banks such as Citi and Goldman Sachs have reported sharp falls in profits in their latest earnings, and some British ones such as Royal Bank of Scotland are in the midst of large-scale job cuts.

Jon Cunliffe, who is responsible for financial stability at the BoE, said banks probably had more restructuring to do -- especially in underperforming investment banking divisions -- but that investors needed to lower their expectations too.

"There is clearly at present a wide gap between banks' disappointing returns on the one side and investors' expectations on the other," Cunliffe said in a speech in London.

Investors had the most pessimistic outlook on banks' ability to increase the value of their assets since the 2011-12 euro zone crisis, he said, even though they were not so concerned about banks' resilience as they were then.

Institutional investors who owned bank shares needed to accept that the types of returns of around 15 percent a year on equity that banks achieved before the financial crisis were no longer achievable, Cunliffe said.

Global interest rates had fallen, and regulators did not allow banks to take the same risks as before, he said.

Targets now stand at around 11.5 percent, but Cunliffe said this may still reflect "factors that are still inflating required returns beyond the levels merited by risk".

One possible reason was that asset managers for institutions with fixed liabilities -- such as pension funds -- were under pressure to continue to generate high returns even after a big fall in interest rates.

Another was that some fund managers might also favour risky shares because the upside to them of outperforming rival funds was greater than the downside of underperforming, he added.

Regulators also needed to be clear that they were not seeking further significant tightening of capital requirements.

British banks' returns on retail lending stood at around 10 percent a year, once the costs of past misconduct were taken into account, while business lending generated returns of 8-9 percent -- roughly in line with capital costs, Cunliffe said.

But their investment banking arms only generated 5 percent, suggesting parts were "not economically profitable" and in need of trimming.

"Banks' staff costs have not fallen anywhere near as much as shareholder returns," Cunliffe said.