The shadow of Brexit hangs over the entire UK economy and casts a particularly murky cloud over the banking sector, notably Lloyds Banking Group, which has little international exposure to offset the risks of a damaging no-deal departure. Some even argue that its share price could crash 50% by the end of the year if things go awry.
You might think that Barclays (LSE: BARC) has some respite due to its investment banking arm, which offers some international diversification, but this has been one of the least profitable parts of its operation, with pre-tax profits recently falling from £1.4bn to £1.1bn, at a time when the UK bank posted a rise in profits from £200m to £600m.
Barclays UK’s retail banking business is at risk from any economic damage caused by a no-deal Brexit, but there is another danger out there – negative interest rates. These aren’t a thing in the UK yet, but they could be edging closer.
This is now a major concern in Europe. Eurozone rates are already negative at -0.4% and reports suggest that European Central Bank (ECB) president Mario Draghi will cut them again on Thursday. German banks are already thought to lose €2.4bn a year as a result.
Last week, Deutsche Bank CEO Christian Sewing and Commerzbank CEO Martin Zielke warned the ECB that more rate cuts would risk serious side effects, driving up asset prices and further squeezing savers, while doing little to revive the slowing economy.
In the UK, base rates stand at 0.75%, and Bank of England Governor Mark Carney is said to be no fan of negative interest rates, but as the unthinkable on Brexit becomes commonplace, we couldn’t rule this out either. Globally, some $15trn of bond debt, a quarter of the total, now trades at negative rates.
Last month, Barclays CEO Jes Staley also warned of the danger that risk-free money can create asset bubbles, which could quickly burst if rates fall again. They would also tighten the squeeze on the bank’s net interest margins, which measures the difference between what banks earn from lending money to borrowers, and what they pay savers, and are already falling at Barclays UK.
In Q2 2017, they stood at 3.7%. By Q2 last year, they had narrowed to 3.22%. In the second quarter of this year, they were down to 3.05%. Margins are being squeezed by competition in the mortgage market and Barclays’ reduced risk appetite in its UK cards business.
Barclays International is suffering a similar squeeze, with net interest margins falling from 4.3% to 3.95% in the six months to 30 June.
Negative rates could prevent the world from slipping into recession, helping keep a lid on credit impairments, but at a high price.
In Denmark, Jyske Bank AS pays customers 0.5% a year to take out a 10-year mortgage. That couldn’t happen here, could it? If it did, Barclays wouldn’t be the only UK bank to suffer. There are other reasons why UK banks are so cheap right now.
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Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has recommended Barclays. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.