IMF Report: Banking Profits Might Not Exceed Cost Of Equity In 2025

A large share of the banking sectors of nine advanced economies, by assets, may not be able to bring in profits higher than their cost of equity in 2025, according to a simulation exercise cited in the “Global Financial Stability Report” by the International Monetary Fund (IMF). Banks could take measures to relieve pressure on profits by reducing costs or boosting fee income, but the report noted that it “may be challenging to fully mitigate profitability pressures.”

The report notes that a “fair” share of banks in North Atlantic economies, which it defines as the United States, Canada and the United Kingdom, are forecast to bring in “adequate” returns by 2025. A variety of “feasible” expense and revenue improvements could help them. The improvement required for institutions in low-interest-rate areas and large euro area nations, however, would be “particularly challenging.”

In large euro nations, almost all banks would have to make changes to cost and non-interest income — “significantly,” at times. It would not be sufficient to reduce expenses to zero without a rise in non-interest income for some banks. And, in low interest rate economies, many institutions show “little scope” for lower costs as costs are at quite low levels as it stands. They would need to increase non-interest income from “very low current levels.”

Evidence also exists that some banks had taken on additional risk because of a lengthy time of low interest rates prior to the pandemic.

To that end, banks in some nations had “modestly” moved their exposure from marketable securities and short-term instruments to loans that were less liquid. Also, some banks sought to raise the maturity risk of their loans to raise yields. And some banks have also had their international exposure increase, which could make for higher currency and liquidity risks.

The IMF report noted that the high levels of liquidity and capital buffers created as of the worldwide financial crisis combined with policymakers’ “decisive policy actions” to keep credit moving to companies and households, as well as keep the economy on an even keel, will assist banks in traversing “these challenging times.”

However, the report noted that it is “crucial that policymakers rapidly employ a combination of policies that maintain the balance between preserving financial stability, maintaining the soundness of financial institutions, and supporting economic activity.”

The report continued, “These include an adequate provision of liquidity by central banks and clear supervisory guidance on the prudent renegotiation of loan terms, the use of the flexibility embedded in existing regulatory frameworks to account for expected credit losses, and the use of existing buffers to absorb costs.”