Retail bank confidence rebounds, in line with stronger investment bank confidence

A survey released by Ernst & Young today indicates that banking confidence has recovered significantly, after a weak first quarter. This is largely on the back of the retail segment of the banking sector that experienced a significant turnaround in prospects. Banking confidence rose from a weak 38 index points in the first quarter of 2011 to 58 in the second quarter.

This is the 38^th quarterly survey conducted to measure confidence in the banking industry, and the research is conducted by the Bureau for Economic Research in Stellenbosch.

Comments Emilio Pera, lead Banking & Capital Markets Director at Ernst & Young, ‘Retail banking confidence recovered after a particularly weak first quarter. Whilst the level of confidence remains considerably below long term levels, latest indications are that prospects for the banking sector are looking stronger than they were in the previous quarters.’

Driving the positive sentiment, says Pera, ‘are the improving financial circumstances of the household sector. Relatively subdued inflation has led to growth in a number of economic indicators. For example, retail sales growth and vehicle sales have both been stronger in the first five months of 2011 than they were in the same time period last year. This has led to a more positive outlook as reflected in consumer confidence levels.’

Pera adds, ‘The rise in retail banking confidence is strongly in line with the major indicators that measure the financial health of households. However, he adds, sustained low interest rates have not thus far provided a strong stimulus for credit growth. Overall household indebtedness, although improving, remain not far from their recent peak level.’

In addition, he notes, ‘There is uncertainty in the property market, which in turn impacts on the mortgage market. The current outlook for property is that prices will move at best sideways in 2011. This in turn affects the risk environment, as banks will be reluctant to lend into a market where they may face a ‘negative equity’ scenario that they have only recently recovered from. ’

On the investment banking side, confidence continued to recover from the financial crisis levels, although they have not yet attained pre-crisis levels. Pera comments, ‘Investment banks have faced more volatile markets than what retail banks have, since the outset of the crisis. It is only really since the middle of 2010 that investment banks finally recovered, and started to report sustained rises in business volumes and earnings.

Investment banks have reported four consecutive quarters of confidence rises, but this still remains at two-thirds of their pre-crisis levels. Strong commodity prices tend to benefit investment banks, by benefiting trading revenues. In addition, trade finance requirements are higher, thus stimulating interest income. However, cautions Pera, ‘global bond markets still remain volatile, and the latest Greek debt crisis indicates that there is unlikely to be any immediate resolution. This in turn, tends to weaken investor confidence, and as a result, the global investment banking market remains vulnerable.’

Other survey findings indicate that the banking sector is responding to current weaker economic conditions by cutting back considerably on expenditure. Says Pera, ‘ there is no doubt that banks are, and have been, strongly focused on costs in more recent times. Whilst they all have differing approaches to maintaining costs, there is a realisation that costs need to be scrutinised far more carefully than was the case prior to the crisis. However, there are some costs that banks will have to unavoidably incur. Continued changing regulatory requirements, and preparation for pending capital needs, all contribute to the high cost environment.

Pera also notes that there was an improvement in efficiency ratios in the second quarter, after a long period of rising cost-to-income ratios. He comments, ‘the moderate increases in income, coupled with a strong focus on cost containment have resulted in more favourable efficiencies. This will need to be sustained in the second half of 2011, if banks are to meet their profit expectations.’

Pera concludes, ‘Stronger retail bank confidence, in line with other consumer and business indicators, is symptomatic of generally improved economic circumstances. Investment banks remain upbeat, with strong business volumes driving higher confidence. Going into the second half of 2011, the risk to banking confidence maintaining relatively strong levels (by recent standards) will be determined by domestic economic prospects as a driver of credit demand. In addition, the risks of oil and commodity prices and the continuing uncertainty over the Greek debt crisis may yet push the global economy back into recession.’