Highlight | What does 2011 hold for banks?

What does 2011 hold for banks?

The UK banking sector has had a tough few years, and 2011 looks to be no exception. Big bonuses are under fire, euro sovereign debt is a constant concern and regulations are set to get tighter. Is there any hope for banks in the coming months?

In late 2008 and early 2009 the UK banking sector was staring into the abyss. The sub-prime mortgage crisis in the US had hit these shores and some high street names faced government bailout or collapse. Since then the banks have been seen as the chief culprits for the resulting recession, and have felt the recriminations of politicians, sections of the media and the public alike.

2010 saw the economy emerge from recession, and with it the banking sector has found stability of sorts. A solid year for the FTSE^® 100 and for equities in general, has seen banks establish a good platform for positive growth, going into 2011.

Many analysts are predicting that this will be a strong year for the FTSE^®, with some even suggesting a possible rise to 7000 and beyond. Could banks be the few bad apples in the basket? Or will investors sense a buying opportunity in the current low levels, and push the sector higher? We look into a few factors which may affect the sector this year:

Euro sovereign debt

Exposure to peripheral euro debt has been a constant thorn in the side for banks in recent times. Whenever there is mention of debt concerns within the EU, banking stocks suffer. The consequences could be catastrophic if certain European nations were allowed to fail (in particular Spain, where UK banks have amplified exposure) and fears over this eventuality may continue to dampen growth over the next year.

Tighter regulations

With the new Basel III accord widely expected to come into play sometime this year, banks will be forced to set aside more capital to guard against future losses. This will likely hit profits and therefore growth, but the extent of the damage will depend on how severe the regulations are, and to what extent this is already priced into the market.

Record low interest rates; rising inflation

Net interest income represents the largest revenue contributor for retail and commercial banking in the UK. The lower the bank rate, the smaller the net interest margins are likely to be for interest-generating products. This hurts profitability for the banks, but is hardly a new development. They have been operating with a 0.5% bank rate for nearly two years, and with inflation on the rise, the rate is due for a hike sooner rather than later. Whether the increased inflation hurts the economy, and equities in general, however, remains to be seen.

Conclusion

With UK banks priced low at the moment, and equities expected to perform well, the domestic banking sector seems primed for an uptrend. However, with the speed bumps of Basel III and in particular euro contagion concerns on the horizon, investors will need to pay close attention to ensure gains do not become losses.

Take a position

Is the banking sector on the road to recovery? Or will euro woes force a further downturn? IG Index offers a variety of ways to profit from movement in the markets, including taking a view on the banking sector, with one of our sector bets.

Alternatively you can spread bet on thousands of individual shares, including banking stocks such as Barclays, RBS, Lloyds and HSBC. We also offer competitive spreads on a wide range of stock indices, forex, commodities and more. Opening an account online is easy and takes just minutes.

Updated: 21/01/11

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