Liberum's latest note on the UK banking sector provides insights on the profitability and risks faced by companies in the sector – and, crucially, it suggests shares may not be as cheap as previously believed.
The broker highlights the unique interest rate environment of the past decade, in which the traditional bank-interest rate relationship broke down due to zero interest rate policies (ZIRP).
As a result, bank net interest margins (NIMs) were squeezed to below-normal levels.
While the reversal of interest rates from the zero bound over the last year has benefited NIMs, this is likely to be a one-off, as competition for deposits increases and the normal relationship between banks and interest rates reverts.
Additionally, the report notes the importance of risk management in banking, as banks must embrace credit risk, interest rate risk, and liquidity risk to maximize long-term, sustainable returns.
It cites the example of Silicon Valley Bank's failure, in which falling deposits forced the bank to liquidate most of its bond portfolio, resulting in a capital raise and a deposit flight that triggered a bank run.
Liberum also compares European and US banks, noting that European banks are subject to stricter and more wide-reaching regulation.
They tend to keep loans they originate on their balance sheets, while US loans are often securitised and sold via capital markets.
The research also suggests that the pricing of risk has been undermined in the current economic climate, leading to excessive and misunderstood risk-taking.
Liberum concludes that European banks are currently experiencing a profitability crisis, as net interest margins are coming under pressure from increased competition for deposits and deteriorating asset quality.
And it provides three simple screens to identify banks' exposure to the macro/rate cycle and highlights the importance of maintaining confidence in the banking system.
Overall, the report suggests that UK bank shares may not be as cheap as previously believed, as banks face significant risks and challenges in the current economic climate.