## Banks Should Help, Not Hinder the Economy

_IMF Blog, October 20, 2014_

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## Bibliographic details
- Authors: Will Kerry, Andrea Maechler
- Published: October 20, 2014

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### Overview and context
- Authors: Will Kerry, Andrea M. Maechler
- Date: October 20, 2014
- Theme: Banks face a challenging transition after the global financial crisis—stronger capital positions but lower profitability—and may struggle to supply sufficient credit to support economic recovery.

### Key findings on bank profitability and risk
- Bank return on equity has fallen to a historically low level, excluding the height of the financial crisis.
- Banks with 80% of the assets of the largest institutions have a profitability gap—their return on equity is less than the cost of equity (capital) demanded by shareholders.
- The profitability gap affects many euro area banks, but it is not isolated to Europe.

### Bank responses to the new paradigm
- Banks have taken steps including cutting costs, selling non-core businesses, and running off portfolios.
- A combination of three strategies could be employed to build and maintain capital buffers without taking excessive risks:
  - Re-pricing (further raising interest rates on loans where possible).
  - Re-allocating (shifting capital toward higher-return activities).
  - Retrenching (withdrawing from some activities altogether).
- Constraints and trade-offs:
  - Banks with less market power may find re-pricing difficult due to competition from stronger banks and from capital market suppliers of credit (e.g., mutual funds).
  - Re-allocation may entail greater risks and is constrained by risk-weighted capital requirements.
  - These constraints may push banks to retrench from certain activities.

### Implications for credit supply and economic recovery
- Transitioning to new business models could limit banks’ ability to supply credit, creating a headwind for economic recovery.
- Simulations in the Global Financial Stability Report indicate:
  - Out of a sample of 300 large, advanced economy banks, only 60 percent (by assets) are strong enough to deliver more than 5 percent credit growth without requiring a significant re-pricing of their loan books.
  - Almost 40 percent of banks require shifting to new business models before being able to meet credit demand when the economy recovers.
  - The share of banks needing significant changes to business models rises to 70 percent in the euro area.
- Some economies that most need a recovery in lending may face particularly tough challenges in providing an adequate supply of credit.

### Policy recommendations
- Policymakers should ensure that bank balance sheets are up to the task of supporting the economic recovery.
- In the euro area, the ECB’s Comprehensive Assessment is a key opportunity to:
  - Clean-up banks.
  - Restructure weak institutions.
  - Resolve nonviable banks.
- Ensure weaker banks do not distort competitive pressures that would prevent stronger banks from undertaking necessary business model changes.
- Banks should adopt a more transparent pricing model that better reflects the underlying risks they are taking.
- Regulators should consider whether barriers to nonbank credit supply could be lifted, accompanied by new tools to prevent the build-up of risks outside the banking sector.

*Banks Should Help, Not Hinder the Economy — Will Kerry, Andrea M. Maechler, October 20, 2014.*

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## Content in this bundle

- **Full Report**
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## References

- [Global Financial Stability Report](http://www.imf.org/external/pubs/ft/gfsr/2014/02/index.htm)
- [previous blog](http://blogs.imf.org/2014/10/15/a-mirage-not-an-oasis-easy-money-and-financial-markets/)
- [https://www.imf.org/wp-content/uploads/2014/10/figure1_17b.jpg](https://www.imf.org/wp-content/uploads/2014/10/figure1_17b.jpg)
- [https://www.imf.org/wp-content/uploads/2014/10/gfsr-vinals-blog-chart-rev.jpg](https://www.imf.org/wp-content/uploads/2014/10/gfsr-vinals-blog-chart-rev.jpg)

_Source: https://www.imf.org/en/blogs/articles/2014/10/20/banks-should-help-not-hinder-the-economy_