The stock market… thinks banks are barely able to earn more than what investors charge them for funds. The reasons are complex but boil down to this: rock-bottom or negative interest rates, tougher regulation and weak economic growth have severely squeezed bank profitability.
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The point is illustrated well by a recent study by Natasha Sarin and former Treasury Secretary Larry Summers, both of Harvard University, and presented at the Brookings Institution. They decided to assess the stability of banks not as regulators do, which usually means looking at capital (such as shareholders’ equity), but as markets do. They examined the behavior of common shares, preferred shares, options, credit default swaps and various valuation yardsticks.
They discovered that markets think banks are much more likely now to lose half their market value than before the crisis. They interpret this as a “decline in the franchise value of major financial institutions, caused at least in part by new regulations.” The counterintuitive implication: The bevy of rules designed to make banking safer may, by endangering their long-term viability, ultimately achieve the opposite.
… investors think that banks will be earning negative returns on their assets, after costs. And indeed, the Institute of International Finance, which represents global banks, finds that since 2010, European, Japanese and U.S. banks have on average been earning less than their cost of capital.