A year ago, few would have predicted the scale of the crisis that consumed the banking sector during 2008. So making predictions for 2009 isn't so easy. But with so much government intervention - and with the state itself having become major shareholders in such high street names as Royal Bank of Scotland, and the soon to be merged Lloyds TSB and HBOS - then 2009 is certainly set to be challenging for the banks.
One of the big issues that could dominate the sector is the potential for conflict between what banks want to do as a recession takes hold and what banks will be allowed to do by their government shareholders. The UK's economy has been forecast to contract at one of the fastest rates in the developed world in 2009, which is going to be grim new for bank customers - especially individuals and small businesses. The understandable reaction of any banker in such conditions is to scale back their lending, or risk a bad debt crisis as borrowers default.
Political pressure
But the government has a totally different agenda - to encourage banks to lend to small businesses and homebuyers at 2007 levels. That's designed to mitigate the worst effects of a downturn, including keeping the 14m people employed by small businesses in work. Indeed, that's likely to prove essential if Gordon Brown still retains any hope at all of winning next general election.
But if bankers prove unenthusiastic about their political masters' plans then they can expect strong-arm tactics. Business Secretary Lord Mandelson has already warned that it's unacceptable for banks to "stop functioning as banks". And Bank of England Governor, Mervyn King, said in November that complete nationalisation of the banks was a serious option should banks fail to begin to lend effectively again. The trouble is that a round of politicised lending could generate a new bad debt crisis - meaning that the new capital pumped in by the government could be consumed by provisions. And with such poisoned balance sheets, the government could struggle to sell its banks shares once the crisis has passed.
Bad debts and balance sheets
Then there's the scale of the horrors that may already be lurking on bank balance sheets to consider. There isn't a UK bank that hasn't already been hit to some degree from needing to write-down the value of asset backed securities - sub-prime mortgage backed securities in particular. But whilst the worst could be over, there's no guarantees that UK banks could be forced into another round of capital consuming write-downs against asset backed securities.
And banks' historic commercial loan books could struggle as the economy nose-dives. HSBC may continue to be hit by its US sub-prime lending operation. Roughly 70 per cent of HSBC's bad debt charge reflects provisions taken against its US businesses and, as things get tougher in the US, bad debts there could rise further. Meanwhile, in the UK, the likes of Lloyds TSB, HBOS and Barclays could see rising bad debts as the recession claims jobs and small businesses got under. Even Standard Chartered, which is heavily focused on fast growth Asian markets, could see bad debts rise if those markets stumble. With the US economy struggling - it's US demand that ultimately drives growth in many of Standard's markets - then that's not such a far-fetched scenario.
It was a write-down crisis that helped explain the government's recapitalisation of the big lenders. Even those that didn’t take government money - Barclays and Standard Chartered - are raising funds from private sources. Barclays' sold a third of itself to Middle East investors and on terms that might have made government funding look cheap by comparison. And HSBC is the only UK lender that looks well capitalised enough not to seek fresh funds. But if the bad debt crisis keeps on biting into banks’ capital, it's not inconceivable that more funds could be needed in 2009.
Liquidity, and competition
With uncertainty over the quality of bank loan books, don't expect the interbank market to make a complete recovery in 2009, either. While central banks around the world and huge bail-out schemes have done much to bring stability and bolster liquidity, interbank lending remains pricey. And if the market senses that banks could be sitting on yet more big losses, then the fundamental problem that's stopping the interbank market from functioning properly – a lack of trust between banks as to the health of their respective institutions – isn't going to disappear. And with base rates falling, bank earnings will struggle as borrowers pay less to borrow. That's all bad news for lending margins.
Competition - or an absence of it - could also begin to emerge as an issue in 2009. Merging Lloyds TSB and HBOS will create a superbank with a 29 per cent slice of the UK mortgage market and 35 per cent of current accounts. Its creation looks set to undermine the competitive positions of other high street lenders. Add that to growing state control, rising bad debts as the recession bites, and pricey funding, and avoiding bank shares in 2009 looks like a smart move.
