A climate of reform will put the squeeze on the industry's profitability for some time, writes Susan Easton, an investment analyst with Gareth Morgan Investments.
The outlook for the financial sector wasn't exactly crash hot as we headed into 2010. The Basel Committee had just put out its initial proposals regarding changes to bank capital standards, concerns were starting to build over the state of European bank balance sheets and the United States was arguing
over the rules for Wall St and US banks and what shape they might take.
Bank executives were flogged in front of the baying crowd and the process of re-regulation looked like it might turn the world's financiers into dead meat.
A few months down the track and the regulators and politicians are turning the handle on the meat-mincer with much less ferocity.
Last month saw the passing of somewhat watered down financial reforms in the US and the European banks were able to sail through their stress tests in a relatively stress-free fashion. The Basel Committee has also made a partial back-track on its original 2009 proposals by extending the implementation time-frame and making some of the capital provisions less onerous than first suggested.
Perhaps governments are realising that without irresponsible credit we're heading into a world of economic growth far lower than we've known. It might be hard to get votes in that type of environment.
Despite an apparent softening around the edges, financial institutions have not been let off the hook.
One of the main thrusts of recent regulatory reform has been to ensure that banks don't over-leverage again and that their balance sheets can stand up to another crisis.
Banks are moving towards both higher quality and longer duration funding than before the credit crisis. They are also building larger capital buffers than they have had in previous cycles. There may still be an overall cap on the total amount of leverage they can carry.
Importantly, countries such as the US with globally significant institutions are getting themselves into the position where the relevant authority can take control of a large bank should it start to go down the gurgler.
In theory at least, that should prevent another chaotic Lehman-style crisis. While the US Congress has passed the bill that makes it possible, the regulators have yet to draft exactly how it's all going to work. Let's hope they can get that one right.
Financial reform has even made it to the shores of New Zealand, though in a much more sedate fashion and without the need for public fisticuffs.
New Zealand managed to escape the worst of the financial crisis, but domestic banks still had difficulty raising funds because of their heavy reliance on shorter-term wholesale funding overseas.
The Reserve Bank's liquidity policy that came into force in April was designed to deal with this issue and its parameters are broadly in line with what is happening elsewhere.
These regulations require domestic banks to keep enough liquid funds on hand to see them through a 30-day stretch.
They also require the banks to keep a certain level of funding from more stable sources such as retail deposits and longer-term wholesale funding. That scramble for retail deposits is evident in the higher term deposit rates on offer at the local bank branch.
Expect this to be a feature of the market for some time.
Finance companies, building societies and so on are also going to be facing a tighter regulatory regime with new hurdles to jump through in coming months. Certain capital levels will need to be met and there will be some restrictions on related-party exposures. It's likely there will eventually be some sort of liquidity requirement imposed.
But don't expect these changes to be enough to prevent another Hanover.
Improved disclosure and minimum standards are welcome but at the end of the day it depends on whether the company you've given your hard-earned cash to has lent your money sensibly or not.
Global financial reforms passed to date and those still wending their way through the system are likely to reduce the profitability of the sector on a longer-term basis. Issues of executive pay and bonuses put to one side, expect bankers still to be squealing.
It's a delicate balancing act though, pitting the need to ensure the stability of the financial system and the need to keep the taxpayer off the hook in any future crises up against the need for banks to earn an adequate return.
Our transition from a world where banks were more or less just another government department - so assured were their depositors and creditors that should push come to shove, the taxpayer would provide the bailout - is no easy feat. Regulatory supervision of the sector has been off-piste for so long.
Indeed the moral hazard that culminated in the orgy of lending was long pointed out before its consequence was finally revealed. To now ensure that banking system design is sufficiently robust that by the time the taxpayer is called on to rescue the depositors every other creditor (shareholder and bond holder) has been wiped out, should provide a level of discipline that encourages bankers to return to banking and leave the wide-boy mezzanine financing and off-balance sheet tricks of recent years to others.
