Worries about the longer-term profitability of the global banking sector could encourage banks to engage in risk-taking and excessive leverage, warns the Bank for International Settlements.
A new report released overnight by the Bank for International Settlements (BIS), which represents the central banks of 60 countries, has advised both banks and their regulatory supervisors to pay close attention to "longer-term profitability challenges".
The lower profitability of the global banking sector partly reflects cyclical factors, said the report, but it can also be pinned down to more resilient balance sheets and higher capitalisation.
"Market concerns about low profitability may deprive banks of an important source of fresh capital, or encourage risk-taking and leverage by banks, thus placing a premium on robust risk management, regulation and supervision," said the report.
Equity investors remain sceptical towards banks with low profitability, said the BIS – which conducted simulation analysis suggesting that some banks would need to engage in further cost-cutting and "structural adjustments".
Overall, the report found that while major banks in advanced economies have moved away from trading and cross-border activities, there is no clear evidence of a "systemic retrenchment from core credit provision".
Second, supervisory bodies (such as APRA in Australia) should monitor banks' cost cutting and adjustment programs and facilitate the process by "removing impediments where necessary".
Finally, banks and authorities should not become complacent about their progress to data and "press on with the implementation of reform".
Economists agree that the Reserve Bank is likely to remain in inflation fighting mode until December. ...