We’re Heading Towards Another Financial Crisis

It’s almost certain that we are heading towards another financial crisis. That is according to the banking sector’s biggest private equity investor, Christopher Flowers. 

Flowers is one of the industry’s most respected investors. A long time private equity investor, Flowers knows the banking sector well and has raised $15bn since 1998 for his private equity, JC Flowers buyout fund.

His claims are based on the fact that regulation, introduced since the financial crisis, has depressed sector profitability. As a result, Flowers claims that lenders like Barclays (LSE: BARC), HSBC (LSE: HSBA), Lloyds (LSE: LLOY), Standard Chartered (LSE: STAN) and Royal Bank of Scotland (LSE: RBS) will have trouble riding out extended periods of financial instability, leading to another credit crunch. 

Poor returns

Regulations introduced following the financial crisis, were supposed to increase the stability of the financial system. However, these regulation have also depressed profitability within the sector.

A survey of 200 banks last year found that their average return on capital was 9.7% last year, marginally above their cost of capital. And these low returns have also put investors off.

Indeed, according to Christopher Flowers, many investors are being put off by low investment returns which are in the region of 5%, as opposed to the double-digit returns achieved before the 2008 crisis. A return of 5% is not enough to compensate investors for the risk that they are taking on. 

Hefty fines

There is also an increasing amount of concern about the hefty fines being levied on banks by regulators, both here and overseas.

For example, the almost $9bn fine paid by France’s BNP Paribas for sanctions violations has alarmed prudential regulators. The Bank of England’s Prudential regulatory authority has stated that fines were making a “considerable dent” in their efforts to rebuild bank capital levels.

Further, with layers of regulation sapping profitability banks are finding it harder to increase capital levels and keep stakeholders happy.  

Lack of intervention

Things are slightly better across the pond, where a lack of political intervention has allowed American banks to restructure their balance sheets and cut costs quicker than their European rivals.

Still, according to City figures, to achieve the typical bank’s targeted 15% return on equity, the average American bank would have to cut costs by 30%, or increase sales by 15%. On the other hand, European banks would need to slash costs by a staggering 65% to meet this targeted return on equity. 

Nevertheless, it's up to you to decide what course you take following this revelation.

To some, the banking sector may appear daunting. Indeed, the complex numbers and formulas used to value banks can be daunting for even the most experienced analyst.

However, with dividend yields over 4%, banks like HSBC and Standard Chartered could help you to boost your portfolio returns and make 2014 an even stronger year for your portfolio.

To help you analyse the sector, analysts at The Motley Fool have put together a free and without obligation guide to the banking sector called 'The Motley Fool's Guide To Banks.'

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool owns shares of Standard Chartered.