Is Brexit really the end of the world for the banks?

UK bank stocks are now poised to record their biggest ever two-day slump amid increasing concerns about the outlook for the UK’s and Europe’s economy.

Selling at any price

Indeed, since Thursday morning last week, shares in Barclays (LSE: BARC), Lloyds (LSE: LLOY), OneSavings Bank (LSE: OSB) and Royal Bank of Scotland (LSE: RBS) have lost 30%, 27%, 42% and 34% of their value respectively (at time of writing).

Even at the height of the financial crisis, when it became apparent that both RBS and Lloyds required taxpayer bailouts, investors acted with more restraint. Today, it seems that investors are willing to sell their exposure to the financial sector at any price.

But is this fear justified? It’s difficult to answer that question. On one hand, banks around the world are in a much stronger position today than they were at the time of the global financial crisis. However, today there are many other risks facing the banking system including overbearing regulation, negative interest rates, disruption from technology and increased competition.

What’s more, the financial crisis is still fresh in the minds of many investors and few want to be left holding the bag if history repeats itself.

Plenty of capital

After nearly a decade of repairing and rebuilding, banks today are much stronger than they were in 2008. At the end of 2015, Barclays reported a tier 1 capital ratio of 11.4%. Barclays’ core tier one ratio at the end of March 2008 was 5.1%. At the end of the first quarter of 2016, Lloyds reported a tier one ratio of 13%. At the end of 2008 Lloyds’ tier one ratio was 6%.

So, it is clear that these banks have enough capital on their balance sheets to weather at least a short-term a crisis.

It looks as if the sell-off is being driven by more than just liquidity concerns. Barclays, Lloyds, and RBS are now all trading at or significantly below their per-share book values. This indicates that the market believes these banks are will struggle to grow going forward, and it is easy to see why.

Struggling to find growth

Lloyds is the UK’s largest mortgage lender. Any slowdown in the demand for houses, or increase in the value of non-performing mortgages, will seriously harm the bank’s growth profile and loan book.

Meanwhile, both Barclays and RBS need the European Union’s ‘passporting’ rights to sell their products across the EU from bases in London. Loss of access to European financial markets would put the brakes on RBS’s recovery and severely slow Barclays’ restructuring, which has been in progress for many years now.

OneSavings is at risk from any economic slowdown the UK. as the bank’s main markets are small and medium sized businesses and mortgages.

The bottom line 

Overall, it looks as if the main reason why investors are dumping bank stocks is uncertainty. The UK’s largest banks are well-capitalised and unlikely to go under anytime soon. That said, any economic slowdown will lead to significant earnings downgrades, dividend cuts and further restructuring for the sector.

It may not be the end of the world for the UK banking industry, but until such time as there’s some clarity on the UK’s economic future and position in the EU, it’s likely investors will remain wary of bank stocks. 

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has recommended Barclays. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.