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Should you sell your bank stocks?

A growing sentiment locally and worldwide is that massive global monetary stimulus has artificially inflated asset prices. The current head of the Financial System Inquiry (FSI) David Murray has warned that this will “cause a correction at some point, which will put more political pressure on financial systems”.

Recent statements reflecting growing fears for banks:

1. Reserve Bank of Australia governor Glenn Stevens commented recently about the “scant” compensation for risk in financial markets.

2. Prior to the comments above, David Murray advocated that the big four would need to hold an additional $23 billion in capital at the recent (FSI).

3. The unlisted and outperforming Peters MacGregor Global Fund (PMGF) is managed by Wayne Peters, whose investing style is very much informed by Warren Buffett. He stated in early July that Australian banks are heavily reliant on the goodwill of the offshore bond markets to fund housing loans. U.S. banks like Wells Fargo & Co (NYSE: WFC) fund home lending by using 90% of funds held on deposit. In Australia that figure is only 65%, which leaves Australian banks at the mercy of world bond markets to fund the balance.

4. In revealing full-year results for Australian Foundation Investment Co.Ltd. (ASX: AFI), managing director Ross Barker stated that he would agree with any tightening of the banking system that would ”perhaps reduce a bit of their…returns”.

How will banks be affected?

According to a report in today’s AFR, the banks’ price fall scenario could well occur:

If we see big losses for the banks courtesy of a correction in both share and property prices.

Or if banks’ profits are reduced by regulation requiring higher capital reserves. If forced to hold more capital, the overall returns will be reduced, especially for the Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC), National Australia Bank Ltd.  (ASX: NAB) and Australia and New Zealand Banking Group (ASX: ANZ). This in turn would restrict the ability of banks to keep paying dividends at current levels, provided they don’t derive extra profits from other sources.

Or if we see a reduction in activity levels at the banks. Riskier activities conducted by certain sections of the banks may be curtailed so as to protect customer deposits.

Or if the banks’ cost of borrowing rises. Bond holders may be required to accept more risk. In doing so they would demand a higher interest rate.

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