Certainly, by measures such as dividend yields and underlying asset value, banks have rarely been as lowly rated. Few other stock market sectors offer the same dividend yields, combined with a record of growth. Superficially, there are many measures that suggest today's stock market judgement is still too pessimistic on the banking sector. It has taken great fear, with investors anxious about what may yet emerge from the credit crunch, for bank share prices to move so far from historic valuations.
Recent weeks have also brought more encouraging news, with decisive action by the US authorities. There has also been better international co-ordination, with good liquidity support from the Bank of England and European Central Bank. And, at least in the US, where interest rates are below the level of inflation, banks with sound balance sheets should now be able to make money.
Yet, risks remain. Analysts continue to debate how much more bad news might emerge from banks, but what is clear is that the future will not be business as usual. A price will be exacted for all the public money involved in restoring the health of the financial sector. Authorities and politicians alike know that the excesses of the banking bubble must be unwound, with sounder lending practices in future. And, unfortunately, the process of rebuilding assets seems likely to involve bank dividend cuts.
Other valuation measures should be questioned, too. Measuring underlying asset value is not simple. In some banks, part of the asset base represents goodwill - an intangible “asset” created by accounting treatment of acquisitions. In recent years, banks' growing profits have been built by piling much higher levels of lending activity onto a relatively small underlying asset base. It seems likely that regulators will respond to the current crisis with some new rules that involve more prudent ratios and a need for more ready cash to be retained.
It is simply too soon for investors to see what they are buying in the bank sector. The business model will change, with greater regulation, more transparency and much less use of leverage. The shadow banking sector that includes many investment banks' customers, such as hedge funds, will also see more regulation. Investors can afford to be patient, and to buy banks only when the business model is clearer.
