Large banks are emerging from the financial crisis with much stronger balance sheets, but need to adjust their business models to the new economic reality of low profitability and heightened regulatory requirements, the International Monetary Fund said Wednesday.
According to the IMF’s latest Global Financial Stability Report, which analyzed 300 large banks in advanced economies, banks hold significantly more capital than before the crisis, but those representing almost 40% of total assets do not have a sustainable business model that can supply adequate credit to support the economic recovery.
“In this new paradigm … banks need to change the way they operate to ensure that they can build and maintain capital buffers without taking excessive risk and still meet credit demand,” the report recommends.
An overhaul of banks’ business models, the IMF says, is “likely to entail a combination of repricing current business lines, reallocating capital away from low-risk assets and — in some cases — selective retrenchment or even restructuring.”
In a simulation exercise, the IMF found that the repricing needed by some banks to close their return-on-equity gaps and generate sustainable profits may not be realistic, “particularly if done on a stand-alone basis and not followed by other market participants.” For example, 20% of banks would need to raise lending margins by more than 50 basis points on their entire loan book.
“Repricing is likely to be easier with bank-dependent borrowers, such as in small- and medium-sized enterprises and consumer credit,” the report noted.
According to the fund, banks accounting for 80% of total assets of the largest institutions currently have a return-on-equity gap, in which their return on equity is lower than the cost of capital demanded by shareholders.
Investors are demanding high returns from banks, the IMF said, “with the cost of equity having risen since before the crisis.”