A less profitable banking sector

Banking in the industrial world will be less profitable in the years to come than in the past. This is even after those economies recover- whenever that happens. One reason is that capital requirements will go up as regulators push banks towards lower leverage. Another is that high-risk products will come under the scanner and banks won't find it easy to hawk these.

Of course, there will be a shakeout and capacity will shrink. But that doesn't mean survivors will have easy pickings. Demand too will shrink - a whole range of securitised products and derivatives will find very little demand. An article in FT notes:

According to analysts at Citigroup, European banks earned a return on equity of 18-23 per cent between 2003 and 2007 compared with 12-15 per cent in the mid-1990s.This shift mainly reflected more borrowing: European banks’ leverage – the value of their assets as a proportion of their equity – rose from 24 times on average in 1995 to 39 times in 2007.

What about the banking sector in India? Here too, expect banks to be operating at a capital adequacy of around at least 15%. But volume growth will be strong- 20% or so- and margins are still higher than those elsewhere. Besides, the massive churn in thinking occasioned by the present crisis will mean continued caution in opening up to foreign banks, which are potentially the most potent threat to the profitability of domestic banks.

In short, over the next five years, expect the banking sector in India to be almost as profitable as in the recent past- and an outperformer in the Indian economy.