Can you REALLY make a fortune from the banking sector?

A lukewarm outlook for the British economy has kept market appetite for our banks firmly on the backburner in 2016.

Indeed, industry giants like Lloyds, Barclays and RBS — firms that generate most of their earnings from their domestic markets — are all trading at a significant discount to levels seen at the start of the year.

Investors had already factored-in a prolonged period of low interest rates, a situation that has already heaped significant pressure on the profitability of Britain’s banks. But June’s EU referendum has thrown an extra gallon of petrol onto concerns that earnings weakness could be here to stay.

Indeed, the CBI last week cut its 2017 GDP growth forecast to 1.3% from 2%, the institution citing the impact of rising inflation on household spending and uncertainty as Britain extricates itself from the EU hampers business investment.

Foreign fears

It’s little wonder then that share pickers have been piling into the London Stock Exchange’s gaggle of internationally-geared banks to shield themselves from the worsening UK economy.

This rejuvenated buyer appetite has propelled Asian powerhouse HSBC’s stock value 31% higher since the summer’s vote. Meanwhile, European and South American giant Santander has enjoyed a 20% rise.

But that’s not to say these territories carry no risks of their own. While I believe a backcloth of rising personal wealth levels in emerging markets should drive banking demand in the long term, these banks are currently battling to grind out earnings growth in an environment of increasingly-dovish monetary policy.

Just last month lawmakers in Brazil, a key market for Santander, cut interest rates for the first time in four years in a bid to ease the country’s painful recession. And further hefty interest rate cuts are touted as we move into 2017.

Talk of potential asset bubbles — whether across commodity markets or within China’s property sector — also continues to do the rounds. Meanwhile, signs of cooling global trade add an extra layer of risk to banks in these regions.

Unifying woes

One factor unites all Britain’s major banks however, and that’s the seemingly endless rise in misconduct-related financial penalties.

Santander, Barclays and Lloyds set aside an extra £30m, £600m and £1bn respectively for PPI-related matters in the third quarter. RBS came away without further charges, but latest data from the Financial Ombudsman Service suggests further penalties are just around the corner — the body received almost 43,000 more claims between July and September.

A touted FCA deadline of 2019 for new PPI claims provides the banks with some relief looking ahead. But this scandal isn’t the only millstone to hang around the sector’s neck — RBS and Barclays still face hefty penalties for the sale of sub-prime mortgages in the US leading up to the 2008/09 financial crisis, for example.

Meanwhile, the loss of critical ‘passporting’ rights — that allow Britain’s banks to sell their financial products into the EU — are also in danger of being put to the sword should continental lawmakers, as is becoming increasingly likely, choose to play hardball with the UK during Brexit negotiations.

This scenario would punch a hole in the earnings performance of the UK’s financial powerhouses, and could eventually lead to an exodus onto the continent.

In short, I believe the vast array of problems nibbling away at Britain’s banks makes investment in such firms a risk too far, certainly at the present time.

Be brave and keep buying

But Britain's decision to exit the EU doesn't mean investors should run for the hills. After all, with volatility comes opportunity.

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