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Cut and thrust

13 July 2016 By Antony Currie

America’s banks require more creativity. That conjures up fears of accounting fiddles or overly complex products with zero economic or social benefit. The truth is more simple: Return on equity at the nation’s lenders and investment banks remains too low, and banks need to try something new.

Income statements for the second quarter ought, at least, to look better than for the first three months of the year. The likes of JPMorgan, which kicks off earnings season on Thursday, Goldman Sachs and Bank of America all look set to best their first-quarter showing, according to Thomson Reuters estimates. Stock deals, the trading environment and mortgage refinancing have all picked up.

Trouble is, earnings are set to be worse than last year’s second quarter, meaning few are likely to earn enough to beat their cost of capital – which is usually pegged at around 10 percent. Of the larger banks, only Wells Fargo and U.S. Bancorp are likely to do so. That has often been the case for several years now. Executives everywhere have been trying to improve matters, whether by dumping unprofitable businesses, crimping expenses or laying off staff.

That can only do so much when top-line growth is stagnant. Citi and JPMorgan have gotten their efficiency ratio – which measures how much per dollar of revenue is spent on operations – below 60 percent. That’s impressive; the average of banks tracked by Credit Suisse analysts is around 63 percent, for example. But it’s not enough to breach the cost-of-capital threshold. And few are likely to manage to do so in the next couple of years, according to Thomson Reuters estimates.

Creating, or more likely adapting, new technology is therefore becoming all the more crucial. It’s already happening, in part thanks to so-called fintech startups in payments and lending highlighting how inefficient many traditional processes are. Technology can help speed up decisions, improve customer service and eliminate swaths of attendant costs.

But it’s slow going, whether thanks to regulation or institutional inertia. Those banks that manage to speed up modernizing their business are likely to earn the enduring respect of their shareholders. They should get cracking.

 

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