UK banks’ cost of equity reaches 19%
With domestic retail borrowers under rising pressure, does political risk matter more than strong profitability and capital buffers at UK banks?
Investors might be forgiven for being a little concerned about UK banks, following the now infamous mini budget from Kwasi Kwarteng, the country's chancellor.
Sweeping tax cuts funded by borrowing, in the face of rampant inflation, caused sterling to crash in late September. UK borrowing costs soared – and the pension, mortgage and housing markets were paralysed.
UK banks’ share prices consequently fell so much that their implied cost of equity rose to 19%, according to Berenberg. This means that investors consider UK banks even riskier than their peers in Italy, where the implied cost of equity is 17%, even after the election of a far-right government on September 25.
UK banks would now need to make a return on equity of almost 20% to sufficiently reward investors for their perceived risk such that they traded above book value.
This bearish reality is a long way from the rosy picture that banks and sell-side analysts have tried to tell for the last few months: that UK banks have more capital and their borrowers are less leveraged than before 2008, so are well-placed to benefit from rising rates today.