Days of mega profits are over, says report

Banks globally may be forced to hold on to more assets to cushion against economic downturns. Photo / Martin Sykes

New Zealand banks must face the "uncomfortable truth" that the regulatory response to the financial crisis means they will not again see the high level of profitability they enjoyed in the preceding years, says Pricewater-houseCoopers.

The accountancy firm this week released a report on the future shape of the global banking industry.

While much of the document deals with the issues faced by banks in markets such as Britain and the United States which were badly mauled and subsequently bailed out by governments, PricewaterhouseCoopers partner Paul Skillender said there were some important implications for the Australasian industry.

The report says the banking industry and investors "must accept an uncomfortable truth: lower returns on equity will become the norm".

"It is recognised that previous levels of leverage will no longer be acceptable in the future and political pressure to keep lending prices low to encourage economic activity will slow the pace of revenue growth."

A major factor in the outlook for lower profits internationally is the prospect of changes to capital adequacy rules which seem likely to force banks to hold more assets as a buffer against adverse conditions.

"We will see this pressure here, the level of capital required will increase," said Skillender.

Apart from an increase in the base levels of capital, Skillender said it was increasingly likely that international regulation would move from a "pro-cyclical" to an "anti-cyclical" capital requirement.

Under the existing pro-cyclical Basel Accord requirements, as credit quality deteriorates in a downturn, banks have to hold more capital which acts as a brake on lending.

"The problem is that usually acts counter to what the central bank wants. Ideally you want the banks to become a little bit more conservative heading into a boom and let the brakes off a little bit going into a recession so that you don't counter all the fiscal and other monetary policy stimulus activity you've got going on.

"The way to address that is to force the bank to build up its buffer of capital during a boom and then that buffer is available as you head into a recession to offset some of the losses and writedowns you'll be taking."

Skillender said bank shareholders had been getting pretty good returns over the past five to 10 years.

"Arguably that was at the expense of the banks building up a big enough buffer. If banks are prevented from releasing some of those reserves, investors are going to see their returns decrease as you go into boom periods.

"Hand in hand there will be more pressure to ensure banks' pricing is fair and reasonable so they won't be able to compensate for that higher level of capital as much as they'd like to. The end result is they're going to get a lower return on equity."