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Banks struggle to find the right business model

Banks need new sources of revenue or will remain chained to the wheel of endless cost cutting as they face continuing uncertainty about how to best allocate their capital.

The banking industry might well be better capitalized than ever before, with more diverse and resilient funding and liquidity. And tough stress testing in the US and now in Europe through the asset quality review that was last year’s pre-occupation, might offer some comfort that banks are not stuffed with rotten assets, as they were in 2008. But that alone does not make the banks good investments for providers of equity or debt capital.

Further reading

• Regulators still calling the shots

• From exceptional items to a cost of doing business

• Going digital could be a do-or-die challenge for banks

It’s not clear yet that banks are running business models that can sustainably generate a higher return on equity than their cost of equity in future. Equity analysts’ key argument to asset managers to buy bank stocks remains much the same as it has for the past three years: they are cheap. But banks are cheap for a reason.

Revenue generation is likely to remain moderate as margins in retail and commercial banking are unlikely to widen until interest rates increase, and any improvement in earnings from capital markets activities will require trading volumes to increase materially.

Universal banks are still wrestling with the best way to allocate capital to different businesses both within their corporate and investment banking divisions – businesses that have been hardest hit by higher regulatory capital requirements and poor volumes and margins – and between these wholesale divisions and retail and others, such as asset management and transaction services.