IMF Identifies 9 Vulnerable Big Banks -- WSJ

By Josh Zumbrun Features Dow Jones Newswires

This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (October 12, 2017).

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The International Monetary Fund said some of the world's largest financial institutions -- including Deutsche Bank AG, Citigroup Inc., Barclays PLC and a few Japanese institutions -- could struggle in coming years to remain sufficiently profitable.

"About a third of banks by assets may struggle to achieve sustainable profitability, underscoring ongoing challenges and medium-term vulnerabilities," the IMF said, referring to the world's most important financial institutions.

The IMF's critique of the banks came in its biannual Global Financial Stability Report, released Wednesday as finance ministers and central bankers from 189 countries gather in Washington for the annual meetings of the IMF and the World Bank.

It is unusual for a body like the IMF to identify banks by name. The report named nine financial institutions in all, Besides Citigroup, Deutsche and Barclays, it also named Société Générale, Italy's UniCredit S.p.A., the U.K.'s Standard Chartered PLC and Japan's Sumitomo Mitsui Financial Group, Mizuho Financial Group and Mitsubishi UFJ Financial Group as likely to deliver subpar profits.

All nine declined to comment on the report.

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"Institutions that are not profitable might not be able to generate enough capital in the future should adverse shocks hit," Tobias Adrian, director of the IMF's monetary and capital markets department, told reporters. "It might become a financial stability risk not to be profitable."

The IMF said the consensus among private-sector bank-industry analysts was for a return on equity of less than 8% for each of those nine banks in 2019. In previous research, the IMF has said that banks' cost of equity -- that is the return stock investors expect on their holdings -- is at least 8%. Banks need to earn above this threshold to remain consistently profitable and otherwise may face difficulty building capital for a rainy day, the IMF said.

Regulators and international policy makers are typically circumspect about questioning the profitability of specific banks, often preferring to speak more generally out of concern they could weaken institutions that are already vulnerable and risk destabilizing the global financial system. But the global economy is in a broad upswing, and financial markets have been broadly supportive, creating a window for the IMF to speak more boldly.

The report looked at the 30 international banks the Financial Stability Board, the international regulatory body, has deemed to be global systemically important banks, based on their size and complexity and potential ability to wreak havoc across the global financial system should they stumble. All told, the 30 institutions hold more than $47 trillion in assets, a sum representing more than one-third of global banking loans and assets.

Some of the IMF's views are already conventional thinking on Wall Street. Deutsche Bank's stock, for example, trades at less than half of its book value, or net worth, and has traded well below this level since 2010. This suggests investors don't believe it will deliver returns that create value in the long run.

Deutsche Bank has struggled to maintain profits during a prolonged turnaround hobbled by high legal fees and technology costs and capital constraints on dominant businesses such as fixed-income trading. Another challenge for the German lender is that retail banking in its home market is less profitable than that business is for many big banks elsewhere. Deutsche Bank raised $8.5 billion earlier this year by selling shares, putting pressure on executives to prove they can use the fresh capital to boost profits.

Citigroup investors have grown more confident in the bank's outlook. Over the past year, the shares have risen more than 50%, almost three times the gains of the broader market. The stock also is trading near its book value, or net worth; it last hit that level in September 2008. And in June, the U.S. Federal Reserve gave Citigroup a green light to return nearly $19 billion in capital to investors through higher dividend payouts and increased share buybacks.

The British banks named in the report, Barclays and Standard Chartered, have been shedding asset and business lines to become more profitable. Italian UniCredit, over the past year, took a number of actions to shore up its finances and improve its profitability, including raising EUR13 billion in fresh equity, selling a multibillion portfolio of bad loans and cutting costs.

Despite the handful of projected laggards, the IMF report said that overall, the largest global banking institutions have become "more resilient since the crisis with stronger capital and liquidity." Collectively, the largest banks have higher capital ratios, more liquidity and fewer assets than at the beginning of the decade.

The report cited progress at U.S. banks in particular that raised capital and unloaded noncore businesses. The other seven U.S. banks that are considered systemically important -- State Street Corp., Wells Fargo & Co., J.P. Morgan Chase & Co., Goldman Sachs Group Inc., Morgan Stanley, Bank of New York Mellon and Bank of America Corp. -- were expected to be comfortably profitable through 2019. By 2019, just 29% of assets in the systemically important financial institutions are expected to be in laggard banks, down from 39% over the 2012-16 period and 51% from 2008 to 2011.

Yet "problems in even a single" one of such institutions "could generate systemic stress," the IMF said.

While the IMF isn't a bank regulator, its report represents an effort from the institution to apply pressure to national regulators and the financial institutions themselves to continue taking steps to ensure the safety of the global financial system.

The IMF said regulators should press their financial institutions to resolve nonperforming loans, drop unprofitable lines of business and develop plans to unwind the bank in case of failure.

For many market observers, the financial crisis of 2007 to 2009, in which Bear Stearns, Lehman Brothers and American International Group nearly brought down the global financial system, looms large.

The report said Japanese banks were particularly struggling to earn high returns due to low interest rates. Mizuho and Mitsubishi, for example, reported lower net profit in the year ended March 2017.

Problem banks have either been slow to deal with bad loans from the financial crisis or, as in the case of some European investment banks, had undefined and unprofitable business models, the report said.

"Without a more concerted effort to reduce nonperforming assets and improve business models, financial stability concerns could be reignited in the euro area," the IMF said.

Jenny Strasburg, Margot Patrick, Giovanni Legorano and Kosaku Narioka contributed to this article

Write to Josh Zumbrun at Josh.Zumbrun@wsj.com

(END) Dow Jones Newswires

October 12, 2017 02:47 ET (06:47 GMT)