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Industry voice: End of the traditional income model
This time last month we were saying the stress testing of European banks was a light at the end of a tunnel – we just weren’t sure whether it was daylight, or an oncoming train.
This month, having been tested with the astoundingly high success rate of only seven failures out of 91 banks examined, it is still unclear although daylight holds the immediate upper hand as evidenced by soaring bank prices in the week following the publication of the results.
But in the US, which had far more stringent bank test requirements, there are still hidden and mounting bank losses explaining why bank lending in the US is continuing to shrink at an annualised rate of 7 per cent.
This is on the back of US banks being forced to raise an extra $100bn (£63.75bn) in capital by regulators. The figure ordered from European banks is just $4.5bn. This suggests the hidden losses on the continent are far greater than in the US and bank lending is shrinking as a result.
The UK government has already called for banks to lend more to small businesses, but there seems to be a reluctance to do so. Repairing a balance sheet takes a long time and there is anecdotal evidence British banks are refusing to carry out written valuations in order to disguise what proportion of their commercial book is in breach of covenant.
The longer it takes banks to recognise their losses, the longer it takes for them to start lending again. If banks don’t lend, the economy stagnates and we become stuck in a vicious circle of banks needing to maintain and grow capital while business cries out for it.
This is what happened in Japan where the banks refused to admit the scale of their losses, trying instead to trade their way through. The Japanese simply found other places in which to invest in order to maintain their income and monetary requirements. They had to look overseas for returns, which is something UK equity income investors would be well advised to do if they have not already realised the traditional equity income model is wobbling.
Those dependent upon the usual UK stalwarts of the banks and BP for income have seen it evaporate quicker than England's World Cup dreams. To be fair, the warning signs have been there, but BP may well be the final straw.
