Frontpage News 2014 New regulation req...

New regulation requires higher earnings

20 February 2014

The new banking regulation CRD IV came into force at the turn of the year. By this, requirements for banks' capital adequacy are tightened. This is done partly for the sake of financial stability. It makes sense, but it also has consequences for banks, for owners and customers. 
 
The new capital requirements dictate a higher equity in banks. This means that banks must either make more money and transfer a larger profit to equity, reduce loans or issue new shares.

Bank shares traded in the current situation are generally very low priced. In many cases, they are traded below the value of the equity.

"Approximately 80 percent of the Danish listed banks had at the end of 2013 a price-book value of less than 1. That is, one Danish Kroner’s equity in a bank could on average be purchased for less than 1 Danish Kroner via the stock market. This is due to the market's perception of i.a. the earnings prospects being pessimistic. As a shareholder of non-financial companies, you are typically better off, since the share price is higher," says Chief Economist at Bankers Niels Storm Stenbæk.
 
The market price for 1 Danish Kroner’s earnings in a bank is very high. In other words, a Danish bank share costs a lot compared to the bank’s earnings. It costs, for example, approximately twice of what a bank share costs in Sweden (based on the so-called price-earning (PE) key figures).
 
"A main reason is that the market is more optimistic about the Swedish banks', which i.a. have had relatively fewer losses due to a stronger Swedish economy," explains Niels Storm Stenbæk and continues:
 
"The price of Danish bank shares are also influenced by the fact that the return on equity is significantly below 10 percent, which is currently estimated to be the cost of capital (cost of equity). For the 40 non-financial Large- and Mid Cap companies, the return was for comparison over 14 percent after the first six months of 2013 (latest figures). 21 out of 24 listed Danish banks, accounting for nearly 90 percent, had by the end of 2013 an estimated interest rate below 10 percent."
 
"If the banks now and in the future must be able to raise new equity, and simultaneously provide a reasonable return on their capital, earnings must follow. One must also take into account that banks across Europe will need new capital. This means a greater supply of bank shares," says Niels Storm Stenbæk’’.
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