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What Is Wrong With The Banks?


Whenever there is an earthquake, or a tsunami, it is usually followed by an aftershock. The aftershock is nowhere near as bad as the ‘quake, but it does some damage nonetheless.


Most banking stocks on world markets were decimated by the earthquake that was the financial crisis of 2008. Some further damage is now being done by the ‘aftershock’. This ‘aftershock’ has resulted from the ‘inverted yield curve’.


What is the inverted yield curve?


An inverted yield curve means that long term interest rates are lower than short term interest rates. This is unusual, as the norm in financial markets is for long term interest rates to be higher than short term interest rates.


Why has this occurred in 2019?


After the financial crash of 2008, the world’s major central banks reduced interest rates to near zero.


Most institutional investors such as pension funds, insurance companies and managed funds are obliged to invest a certain percentage of funds under management in ‘risk free’ and low risk investments. The most accessible low risk investments are government bonds, issued by countries with good credit ratings.


Therefore, even if interest rates are zero, or are negative, for government bonds, these investors are forced to buy these bonds with a portion of funds under management because there is no other accessible alternative.


Most of these institutional investors are now investing a greater portion of funds under management in risk free and low risk investments as their capital base was eroded by the crash of 2008, and they have persued much more cautious investment strategies since then.


How does this impact the bank shares?


A bank borrows short term (from depositors who may wish to withdraw their funds at anytime) and lends mostly long term to customers seeking funding, normally repayable over a 10 or 20 year period.


Long term interest rates are normally higher than short term interest rates, and this creates a profit margin for the bank.


However, when long term interest rates are lower than short term interest rates, it is impossible for a bank to make a profit on new lending.


So where do we go from here?


The inverted yield curve occurred in the summer of 2019 but this has since reversed course and is now once again on an upward trend.


Central banks are aware of the difficulties that the inverted yield curve presents for banks, and it is in everybody’s interests that banks make some money on their core activity, otherwise they will just wind down their operations!

However, while long term interest rates are once again higher than short term interest rates, the difference between them, called the ‘spread’ (which creates the bank’s margin) is very low compared to historical levels. It may take some time for this spread to widen and improve bank’s profitability, due to the current anaemic levels of economic growth.


Are all bank shares being impacted by this?


The European bank shares appear to be much more adversely affected than the US banks.


Technical analysis reveals that most European bank shares are currently in a downward trend, whereas most US bank stocks are in an upward trend.


So the US is managing this problem better than the Europeans - but many commentators say that Trump is erratic and unstable?


Which leads us on our next article on Market Topics!


Why POTUS might be good for America (and the market)! CLICK HERE.

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