Banks are out of the ICU and have been released from the Rehab Center. But they are not yet in a position to fully resume a redefined role in society.
As analysts pour over the details of the recent earnings announcements by U.S banks, one thing is clear: The banking system has largely overcome a complex set of self-inflicted injuries. What is less clear is how banks will navigate what lies ahead.
Banks fueled the worst of the 2008 global financial crisis with a combination of three crippling, self-created problems: too little capital, too many doubtful assets and a risk-taking culture gone mad. Many were on the verge of bankruptcy, and the global economy was staring at a depression.
With exceptional public sector support from the Federal Reserve and other government agencies averting the immediate threat of large sequential failures, banks set on the road of balance sheet rehabilitation. They were pushed along the way by markets and regulators, both of which forced the banking system to de-risk, to change harmful incentives and to correct misalignments. And they responded while increasing sector concentration risks, with some large banks getting even larger.
It was far from a smooth process. In the process of bank recapitalization, some sectors of the economy faced harmful credit rationing that undermined investment in productive activities and contributed to persistently high unemployment. Meanwhile, popular anger remained high, fueled by what many considered as an overly lenient treatment by the U.S. Treasury and the Federal Reserve.
And it sure did not help that some banks were inclined to quickly resume some highly controversial practices.
The recent set of earning announcements by banks point to significant progress in overcoming the three big problems. Capital cushions are now big and deep, asset quality has improved significantly, and internal incentives are being re-aligned. In addition, banks seem to have placed part, though not all, of their litigation risk behind them.
Of course, individual institutions vary in the extent of improvement. Some (like Goldman Sachs, JP Morgan Chase, and Wells Fargo) have made very significant progress. Others (such as Bank of America and Citibank) are lagging. In aggregate, however, the sector is now well past the critical stage.
Yet, it is still too early for them to declare victory.
A THREE-STEP PROGRAM
Three major issues need to be addressed for banks to resume a normal life and regain a stable place in society; and their resolution is both consequential and still uncertain…