Bank stocks were hit hard by the 2008 financial crisis. Years of heavy borrowing left many banks exposed, and some of the most trusted names collapsed. Investors faced huge losses as governments stepped in with taxpayer-funded bailouts. In response, regulators introduced strict new rules to prevent a repeat. These measures weighed on profits for years, but the sector has now come through that difficult period. Today, banks are much safer than they were before the crisis. Big investors have returned, helping to push up share prices; some have even tripled in recent years. As valuations edge back towards more normal levels, an important question remains. Do these high-yielding stocks still deserve a place in a portfolio, or have the easiest gains already been made?

Bank stocks’ wilderness years

For more than a decade, the banking sector struggled to regain the confidence of investors. Most professional fund managers suffered significant losses in the 2008 crash and subsequently found the industry difficult to navigate. Investors discovered they lacked understanding of complex balance sheets. Consequently, their appetite for banks' shares vanished for a generation. Even today, many professional investors remain wary because they find the internal mechanics of a global bank difficult to decipher.

While investors remained cautious, regulators rebuilt the global financial architecture. There has been a substantial increase in banks' capital, the cushion that stands between bank assets and insolvency. Core capital ratios, which give the size of this cushion expressed as a percentage of the bank's total risk, were as low as 4% pre-crisis; today, they often exceed 15%. In the UK, the Vickers Report mandated a separation between retail and investment banking operations. This altered the nature of the business and kept valuations low.

Jamie Dimon provided the first credible signal that this era of stagnation was ending. In February 2016, the chief executive of JPMorgan Chase invested $26 million of his own money into his bank's stock. He purchased the shares at roughly $56 per share, which aligned with the company's book value at the time. Dimon realised that the regulatory clean-up was largely complete. He saw an institution that was well-capitalised and undervalued, yet still priced as if it was ruined. His investment marked the start of a decade-long rally that eventually saw the stock price rise more than fivefold. It would take several more years and a radical change in the interest-rate environment for the rest of the market finally to reach the same conclusion.

The return of inflation

The stagnation of the previous decade ended with the return of inflation. Central banks tackled inflation by raising interest rates from near-zero to 5% and, with that, the fundamental engine of banking profit returned to health. This engine is the “net interest margin” – the difference between the interest a bank pays to its depositors and the interest it receives from its borrowers. For years, the industry struggled to generate a decent return in a world where interest rates were near-zero. The shift to higher rates boosted profits.

How much banks paid their depositors played a big role in this windfall – that is, how much of a central-bank rate rise was passed on to savers. When rates went up, banks were slow to increase interest on current accounts. At the same time, they quickly raised the cost of mortgages and business loans. This delay helped to boost profits. In theory, this rise in profits should only be temporary. But it made it easier for a bank to manage future earnings through a “structural hedge”, allowing them to lock in interest rates for several years and smooth profits as rates fall. The result is a more stable and predictable income stream. This improved profitability has transformed how banks manage their capital. After a decade of hoarding cash to satisfy regulations, they are now paying a lot back to shareholders via a mix of dividends and share buybacks. Total shareholder yields, combining dividends and buybacks, now often exceed 10% a year.

Strong recent results from the biggest banks have cast doubt on the idea that upstart digital challenger banks will disrupt them. While the challengers achieved high user numbers and launched attractive software, they lacked the massive and low-cost deposit bases that the traditional banks enjoy. The incumbents used their superior cash flows to adopt the best elements of the digital revolution, investing billions in their own platforms while maintaining the trust and regulatory licences required to dominate high-value lending, such as residential mortgages.

The established banks were also better able to absorb the higher costs of regulation and cybersecurity. For a smaller challenger bank, the compliance burden is often a significant percentage of its total revenue. For a giant bank, it is a manageable operational expense. Some challenger banks, most notably Revolut, have grown to a large size, but the biggest effect of the new banks is a forced modernisation of the older ones.

This combination of rising margins, disciplined shareholder returns and the resilience of the established model has restored the sector's momentum. The banks have demonstrated that they are no longer just safe utilities. They are profit-seeking enterprises with the capacity to deliver high yields to patient investors. The current challenge for investors is to identify which institutions can sustain this performance as the interest-rate cycle matures. The market has recognised the recovery, but the divergence between the winners and the laggards suggests that selection remains critical.

How to navigate the banking market

There are at least three distinct types of banking. Retail banking is the familiar world of the high street, managing residential mortgages and personal savings for millions of customers. Corporate banking offers services to the commercial sector, extending credit to firms and facilitating international trade. Investment banking is a more volatile endeavour that involves mergers, debt issuance and investing in the capital markets. The latter depends on the shifting appetites of the financial markets, which introduces a level of unpredictability that many investors find unsettling. The market typically rewards the steady stability of retail lending with a higher multiple, while it views the inconsistent profits of investment banking with caution.

The main concern for investors is the progression of the interest-rate cycle. Banks generally benefit from rising interest rates because the income they generate from loans increases more quickly than the interest they pay to depositors. However, as rates plateau this advantage often diminishes. Customers eventually move their money from low-interest current accounts into higher-yielding fixed-term products. This shift increases the bank's cost of funding and can lead to a lower profit. Asset quality is another area of vulnerability. Extended periods of high borrowing costs can put pressure on both households and businesses, leading to a rise in loan defaults. The commercial real-estate sector is currently viewed with particular caution, especially in markets where office and retail property valuations have fallen. If a bank has a high concentration of lending in these areas, it may be forced to raise its loan-loss provisions, which hurts profits.

Political and regulatory risks are also a factor. Governments may consider windfall taxes on high bank profits during hard times. Regulators often introduce new rules on capital requirements or consumer protection. Such measures increase operational costs and limit the amount of cash that banks are able to return to shareholders through dividends and buybacks.

Finally, structural shifts in the financial system present long-term challenges. The rise of non-traditional lenders and private credit markets has introduced new competition for corporate lending. Furthermore, the development of digital currencies could alter the traditional deposit-taking model. If consumers begin to hold significant portions of their wealth in digital sovereign currencies rather than bank accounts, the industry's funding costs could rise substantially.

To assess a bank accurately, investors must look past the price-to-earnings ratios used for ordinary companies. Instead, they prioritise the price-to-tangible-book-value ratio. This metric compares the share price against the net value of the bank's hard assets, once intangible items such as goodwill or brand value are stripped away. It provides a realistic view of the bank's worth if it were liquidated today. A bank trading at a discount to this figure suggests that the market believes the management is failing to earn its way, or that the assets on the balance sheet are not as safe as they appear. Conversely, a premium indicates that investors expect the institution to generate superior returns for years to come. In this new higher-interest-rate environment, investors must distinguish between high-quality cash machines and potential value traps.

The efficiency leaders of the banking industry

JPMorgan Chase (NYSE: JPM) remains the undisputed benchmark for the global banking industry. It is the largest bank in the world by a significant margin and is valued at more than double its nearest competitor. This scale allows the firm to simultaneously dominate both investment banking and retail lending. Under the leadership of Jamie Dimon, the bank has maintained a return on equity of nearly 16% while investing billions into its technological infrastructure. While the valuation is high compared with peers, its operational dominance and so-called “fortress balance sheet” provide a unique safety net. It is the go-to investment for those who wish to gain exposure to banking.

Lloyds Banking Group (LSE: LLOY) is a direct bet on the British economy. Unlike its more international rivals, Lloyds Banking Group generates the majority of its profit from domestic retail and commercial lending. Its net interest margin has improved significantly in recent years as it benefited from the shift in interest rates. With a price-to-tangible-net-asset-value ratio of 1.5 times and a healthy return on equity, the bank has become a favourite for dividend-seekers. Its aggressive share buyback policy continues to support the shares even during periods of domestic economic uncertainty.

HSBC (LSE: HSBA) has focused its efforts on the high-growth markets of Asia, which now drive the majority of its earnings. The bank trades at 1.7 times tangible net asset value and delivers a return on equity of 13.7%. For the income investor, the appeal lies in consistent dividends and regular share buybacks. However, the heavy exposure of HSBC to Hong Kong and mainland China remains a double-edged sword. These regions offer superior growth potential, but also introduce geopolitical risks.

NatWest Group (LSE: NWG) has completed its journey from a government-controlled institution back to a fully private enterprise. Many investors will remember the bank as the Royal Bank of Scotland, which rebranded to distance itself from the reputational damage suffered during the 2008 crisis. The bank has shown remarkable profitability recently, with a return on equity approaching 20% in its most recent results. The shares trade at a more modest 1.3 times tangible net asset value, offering an attractive entry point for those seeking exposure to banking. Its focus on digital efficiency has allowed it to maintain a competitive edge.

The recovery candidates

Barclays (LSE: BARC) trades at a discount of 0.8 times to tangible net asset value, despite delivering a return on equity of more than 10%. The market remains cautious regarding its large investment-banking division, which requires significant capital and produces volatile returns, but management recently vowed to return substantial capital to shareholders by the end of this year. If the bank can prove its investment arm is no longer a drag on the retail business, the potential for a valuation re-rating is substantial. It remains an interesting candidate for those looking for value and who are comfortable with higher risk.

UniCredit (Milan: UCG) has emerged as one of the most efficient banks in the eurozone. Under a disciplined management team, the Italian giant has achieved a return on equity of nearly 17%, far outstripping many of its domestic and international peers. It trades at 1.5 times tangible net asset value, reflecting a market that has finally begun to appreciate its streamlined operating model. By aggressively cutting costs and returning capital, UniCredit has proved that a European bank can thrive without the tailwinds of a massive domestic mortgage market.

Deutsche Bank (Frankfurt: DBK) has historically been the sick man of European banking. After years of losses and scandals, the bank has finally returned to consistent profitability, posting a return on equity of 9.2%. Reflecting this, it remains one of the cheapest major banks in the world, trading at just 0.7 times tangible net asset value. The discount is due to its poor reputation, but the structural improvements in its corporate and private banking arms are undeniable. For the patient investor, it represents a bet that the final stages of its turnaround will lead to a revaluation.

The specialists

BNP Paribas (Paris: BNP) is the closest institution Europe has to a diversified American-style giant. It operates a massive corporate and investment bank alongside a stable retail presence across several countries. Trading at 0.9 times tangible net asset value, it offers a diversified stream of earnings and a healthy dividend yield. The bank has successfully used its scale to gain market share as American rivals pulled back from certain European markets. It is a solid choice for those who want exposure to European growth without the concentrated risk of a single-country lender.

Banco Santander (LSE: BNC) has exploited its unique geographic footprint, spanning from Spain to Brazil and the US, to protect itself from regional economic shocks. The bank trades at 1.7 times tangible net asset value and delivers a return on equity of more than 12%. Its diversified model means that when the European economy slows, its Latin American operations often provide a profitable cushion. This geographic spread is its greatest strength, although the complexity of managing such a diverse empire often leads to a slightly lower valuation than its simpler peers.

Standard Chartered (LSE: STAN) provides a unique way to gain exposure to the emerging markets of Asia, Africa and the Middle East. Unlike HSBC, it has a smaller retail presence and focuses more heavily on corporate and institutional banking. It trades at 1.1 times tangible net asset value and has recently exceeded its own profitability targets. It is a primary beneficiary of the rise in intra-Asian trade and is well-positioned to benefit from the ongoing economic development in its core markets. It remains an attractive option for investors looking towards the emerging economies.

Bank of America (NYSE: BAC) is the second-largest lender in the US and serves as a bellwether for the US consumer. It trades at 1.8 times tangible net asset value, a premium that reflects its massive deposit base and its leading position in digital banking. While it is highly sensitive to US interest rates, its diversified earnings from investment banking and wealth management provide stability. It is often seen as a more conservative alternative to JPMorgan Chase for those who want exposure to the American financial system.

Goldman Sachs (NYSE: GS) remains the premier investment bank in the world. Unlike the universal banks, Goldman Sachs is heavily weighted towards merger advice, trading and asset management. This makes its earnings more volatile and dependent on the health of the financial markets. After a period of strategic drift into consumer banking, the firm has refocused on its core strengths. It remains an option for those trying to gain exposure to pure investment banking rather than more traditional lines of business.

The best bank stocks to invest in now

The banking sector has transitioned from a source of risk to a reliable engine of shareholder returns. For those seeking stability, Bank of America offers a good balance sheet and direct exposure to the US economy. Its historical resilience provides a degree of security for investors prioritising long-term capital preservation. Barclays represents a more opportunistic choice. It remains priced at a discount compared with its domestic peers, and the successful execution of its current strategy should allow this valuation gap to narrow, rewarding patient holders. Finally, Standard Chartered serves as a unique vehicle for those desiring exposure to emerging markets. As a UK-listed entity, it provides a regulated gateway to high-growth regions in Asia and Africa.

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Major UK banks should be ready to join in a round of consolidation in European banking. The British economy is stagnant, competition from challenger app-based banks is intense, and the government is determined to tax businesses out of existence. A major takeover of a European bank would put each of them on the global stage, and if they got it right, could power their profits for a decade or more.

In the sector's biggest takeover offer for more than a decade, Italy's UniCredit tabled a $40 billion offer for Germany's Commerzbank, which it has been stalking for years. What happens next remains to be seen. It is very hard to win a hostile contest for a eurozone financial institution, and certainly one as large as Commerzbank.

UK banks should join a unified European financial system

A round of consolidation within European banking is inevitable over the next year. The EU has finally realised it needs a unified financial system if it is to improve its competitiveness. But hold on - surely the major British banks should be taking part in that process? True, Britain is no longer part of the EU. But it is still part of the wider European economy, even if officials in Brussels would prefer that it wasn't. If a major eurozone bank is up for sale, then they should be looking at it very seriously.

Firstly, it is the natural space for expansion. There is not much scope for takeovers within the British banking market, while the US is a very hard market to crack and Asia offers limited opportunities. By contrast, all the major European finance markets are geographically close. A takeover or merger would offer huge scope for cost cutting, while the leaner management that UK banks have perfected would mean it would not be hard to make their branches and loan books more profitable. Continental banks are not very efficient, so it should be possible to squeeze out higher profits.

Secondly, UK banks can afford it. All the major British banks have been racking up huge profits. Lloyds made £6.7 billion last year, a 12% increase on a year earlier; Barclays made more than £9 billion, a 13% rise; while NatWest, now finally fully private again, made £7.7 billion, an increase of more than 24%.

Commerzbank only has a value of £31 billion despite all the takeover speculation, and even Deutsche Bank is only worth slightly over £40 billion. There are plenty of banks across the eurozone that are now relatively small compared to the British lenders. They can be bought without taking on huge levels of debt, especially if a deal can be financed partly in shares.

Finally, the chance won't come again. The German banking industry has been struggling along with the rest of the German economy, but it will probably recover over the next decade if the country manages to restructure its industrial base. If you don't take over one of its major banks now, then soon it will be too late. You won't be able to afford them, and they won't be for sale anyway.

Likewise, the French economy has slumped, but it may revive, and so may the rest of the eurozone. Looking back, Switzerland's Credit Suisse was a major opportunity when it was rescued by UBS in 2023. The UK banks missed out that time around. It would be a shame to miss out all over again. This is a once-in-a-generation opportunity to double or more in size.

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In the world of banking, transformative companies are rare. But when they come along, they can have a big impact. Nu Holdings is one such business. It is upending the status quo in Latin America, tackling a banking sector that is dominated by a cartel of big banks that treat customers poorly. Nu is succeeding through a fanatical dedication to the customer and a relentless drive for efficiency.

Known simply to its 127 million customers as Nu, the firm is an unlikely story of an outsider successfully taking on a banking oligopoly and in the process creating a blueprint for the future of financial services across Latin America, and one day potentially the world. To appreciate Nu's achievement, one must understand the environment it entered.

For decades, Brazilian banks were known for treating customers as little more than a source from which to extract money. Almost a third of the adult population had no bank account at all. In mid-20th century Brazil, protectionist policies enabled a group of five politically connected banks to grow and control nearly 90% of the market. This bred a culture of lazy profitability. Brazilian incumbents maintained net interest margins of around 14% (a key profitability metric in banking), compared with roughly 3% in the US and Europe. They charged astronomical fees and interest rates on credit cards that frequently ran into hundreds of percent per annum. Opening an account was famously arduous and could take days. The atmosphere in branches, marked by armed guards and suspicion, acted as a filter that excluded many. By 2013, 60 million adults were unbanked.

The spark that created Nu came in 2012 from David Velez, a Colombian-born investment professional who had moved to São Paulo to lead the Latin American office of venture-capital firm Sequoia. His attempt to open a local bank account took months. When Sequoia withdrew from Brazil because of a perceived lack of investable technology talent, Velez saw his opening. He realised that the lazy, high-cost models of incumbent banks was a vulnerability to attack.

Velez assembled a small founding team: himself as the strategist, Cristina Junqueira (an experienced banker who knew the Brazilian banking 2022 2023 2024 2025 2026 system well), and Edward Wible (an American engineer who built the bank's technology from scratch). This was perhaps Nu's greatest advantage because many big, old banks run off decades-old software systems that make innovation and cost-cutting difficult. Building from the ground up using cutting-edge technology gave Nu an immense lead that others couldn't match.

For a traditional Brazilian bank, it costs between $12 and $15 per month to service a customer; Nu's cost is about $0.90. This saving is its bedrock. It allows it profitably to serve the unbanked that the incumbents had deemed too expensive to touch.

Nu's radical approach

Nu's first product was a simple, no-fee credit card that rapidly became very popular largely through word of mouth and its radical attitude to customer satisfaction. In a market where banking was synonymous with abuse, Nu's Net Promoter Score (NPS) soared into the 90s (an NPS can run from -100 to +100, so a score in the 90s is incredibly high). The company didn't just provide a service; it also built a movement based on fairness and servicing the part of the population that had been neglected. This organic growth meant it could acquire customers for a fraction of the marketing spend of competitors.

The sceptics' biggest concern was credit risk. Nu's solution was the “low and grow” model. It would issue micro-limits, sometimes as low as £10, to unknown borrowers. This was effectively a test-and-learn strategy. By observing real-time payment behaviour and smartphone data, Nu could predict defaults more accurately than traditional credit bureaux can. As of late 2025, Nu's return on equity (ROE) reached a record 31% (an enormously high number in banking, where the ROE is often closer to about 12%), proving that it could lend to the underserved more profitably than the incumbents could lend to the elite.

How Nu is exporting its model

The Nu model is now being exported. Mexico and Colombia represent the next chapters of the story. In Mexico, where cash is still king and banking penetration is even lower than it is in Brazil, Nu reached 13 million customers in two years. By partnering with retail giant OXXO (which has over 23,000 locations across Mexico) to allow for physical cash deposits, it has overcome its lack of a branch network.

Early this year, Nu received conditional approval for a US National Bank charter in an attempt to move towards the cash remittance corridor between North and South America. Nu is no longer just a new Brazilian bank; it is spreading across the continent.

Nu's shares are not cheap in a traditional sense. Trading at more than seven times book value, they command a significant premium over banks such as JPMorgan, which typically trades at around 1.2 to 2.5 times. But comparing Nu to a traditional bank is a category error. Given its efficiency and revenue growth, it functions more like a high-margin software business. The quality of the management team and the structural cost advantage make it a best-in-class operator. At current levels, the stock is perhaps priced for perfection, reflecting its high-octane growth trajectory. For the patient investor, however, any significant pullback in the share price would represent an enticing entry point into what is arguably the most efficient banking machine on the planet.

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The British banking sector is in rude health. Perhaps the most symbolic moment this year, in the late spring, was the return of NatWest to full private-sector ownership. The government, which at one stage owned 84% of the troubled lender, sold a final tranche of shares. However, while NatWest’s shares have continued to do well, it isn’t the most interesting UK bank on the stock market at present. I think you should consider a punt on its rival, Barclays (LSE: BARC), instead.

Despite being one of the few UK banks that wasn’t directly bailed out by the government in 2008, Barclays has faced criticism for the poor performance of its investment-banking division. In recent years there has even been pressure from activist investors to sell, spin out, or otherwise separate the investment-banking side from the retail-banking business. Nevertheless, CEO C.S. Venkatakrishnan (Venkat) has stuck with a hybrid strategy of keeping the investment bank while trying to build up the retail-banking and wealth-management arms.

Soaring profits for Barclays

So far, this strategy appears to be working well, with Barclays’ revenues and profits continuing to increase. Its stated profits are now 125% higher than they were in 2019, and even after adjustments they are still up by two-thirds. Dividends have more than doubled. True, there are some clouds on the horizon, in terms of ongoing litigation over the departure of disgraced boss Jes Staley, exposure to private-credit loan portfolios and possible banking taxes in the upcoming Budget. However, experts believe that the first is a relatively minor problem, while Barclays is well-placed compared with its rivals.

One big reason to be bullish on Barclays is its valuation. The stock trades at less than eight times estimated 2026 earnings; at a discount of more than a quarter to the value of its net assets; and at a smaller discount to its tangible book value. This makes it cheap, both in absolute terms and relative to its rivals, with NatWest trading at a 2026 price/earnings (p/e) ratio of 8.5, while Lloyds and HSBC both sell for 2026 p/es of 9.5. All three of these banks are priced at significant premia to net assets. The major US investment banks are valued even more highly.

Barclays’ improving fortunes have certainly caught the imagination of investors: the share price has been on a roll. It has risen by nearly a third over the last six months, making it one of the best performers in the FTSE 100 during this period. It has continued to beat the blue-chip index over the past month and three months, and is also trading above both its 50 and 200-day moving averages. As a result, I would suggest going long at the current price of 405p at £9 per 1p per share. In that case, I would put the stop-loss at 300p, which gives you a total downside of £945.

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Revolut will invest £3 billion and create 1,000 jobs over five years to help boost the UK’s financial services sector - all while it looks to also expand into at least 30 other markets and push for 100 million users. And while it still does not have a full UK banking license, could the platform’s ambition for growth be about to skyrocket?

The UK’s banking sector has been due a shake-up for many years now, paving the way for fintechs to sweep in and provide customers with a banking platform that is simple, attractive and modern.

And while the likes of Starling, Monzo and Chase have made reasonable noise, no one is shouting louder than Revolut right now.

This week, it did just that as the fintech opened the door to over a hundred VIPs at its new London HQ in Canary Wharf.

Its new home in the financial district stands out like no other, taking up four floors in the 14-story building, which you can’t miss with its green facade.

Speaking at its opening, chancellor Rachel Reeves said Revolut’s plans take total investment commitments from major financial services companies to over £110 billion in the space of a week, with Blackstone, Blackrock and Paypal added to the mix.

The wave of investments from financial services companies comes months after the government cut unnecessary red tape under the Leeds Reforms.

Reeves said the financial services sector in Britain is worth around 10% of economic output and creates 1.2 million jobs, adding that fintechs like Revolut will “help the country step up”.

“Ever since the financial crisis, our productivity has lagged behind our competitors, and I'm committed to changing that.” Around 98% of fintechs have a significant positive impact on productivity, according to Reeves.

“I am committed to ensuring that Fintech businesses, whether starting, scaling or listing, have the support that they need to succeed here in Britain,” she added.

Revolut’s growth

While Revolut’s UK growth is well underway - and with a sparkling new HQ - its CEO and co-founder, Nik Storonsky, adds that its ultimate goal is to expand to reach 100 million retail customers globally by mid-2027 and be in 30 new markets by 2030.

Storonsky, who is no stranger to Canary Wharf where he once worked at Starbucks over a decade ago, added that Revolut would aim to get a banking license in every country it wants to expand in, saying Revolut will “either get the bank license or just buy a bank”.

Founded in 2015, it now has 65 million customers worldwide, 12 million of which are in the UK.

Revolut is now investing $13 billion (£10 billion) over the next five years, to create 10,000 jobs globally. This includes funding in high-growth regions such as $4 billion (£3 billion) for the UK, $1.2 billion (£880 million) for its Western European hub in France, and $500 million (£375 million) to accelerate its operations in the US.

It is also driving further growth in the European market as well as in new markets across Latin America, Asia Pacific, and the Middle East.

Storonsky added that Revolut would compete with legacy banks in the regions.

“We've got a lot of scale, a lot of product people to develop, and a lot of data scientists. Local banks cannot really afford such investment in tech. So for us, we're innovating and we’re improving products all the time. Sooner or later, our products will be so much better compared to other banks in any country, so it's impossible to compete”.

Investing in Revolut

Fintech's exponential growth provides opportunities for investors, who are looking to tap into private companies. Earlier this year, the Scottish Mortgage Investment Trust, said it was investing in Revolut as the bank hit a $1 billion profit mark.

Revolut is also expected to launch an IPO next year, although this has not been confirmed, and may list on the Nasdaq as many companies continue to shun the UK stock market. We have seen a number of companies over the last year leave the UK stock market.

But its ultimate challenge is to get a full UK banking license, which is still in progress. In July last year, Revolut was granted a UK banking licence with restrictions. It is now in PRA's ‘mobilisation’ stage, which requires new banks to complete the build out of their banking operations.

The sale after 17 years of the last of the government’s stake in NatWest has led some to claim that this was good news for the banking sector. The stock overhang has been removed, and the sale has got the state off its back, they say.

Don’t count on it. Instead, this could herald open season for the government on the UK’s banks, meaning higher taxes, more regulation and the endorsement of new crackpot compensation schemes dreamed up by disgruntled consumers and grievance-chasing lawyers.

More insidious still is the cunning plan by Reform to save £35 billion by the Bank of England (BoE) ceasing to pay interest on deposits held at the central bank by UK lenders. This proposal is so deluded that, almost inevitably, the government will adopt it.

The banks would seek to mitigate the loss of income by removing their deposits from the BoE and either investing in short-term gilts or lending to the private sector at whatever interest rate they could get. The former would bring down yields in the short term, helping the government to finance its borrowing requirement; the latter would reduce private sector borrowing costs. The snag is that the BoE would lose control of market interest rates.

The stimulus to monetary growth would create a spiral of rising inflation and a weakening currency, with the Bank of England and government powerless to stop it. Banks would be trebly hit: by the loss of revenue, the boom leading to bust with multiple insolvencies, and by the lower valuation of their shares in foreign currency terms.

Investors should instead consider the Polar Capital Global Financials Trust (LSE: PCFT). Almost 90% of the trust’s assets are invested outside the UK: 40% in banks (JPMorgan is the largest holding at 7%), 18% in insurance and 38% in financial services such as Mastercard and Visa. The portfolio has returned 19% over one year, 54% over three and 118% over five. Since NatWest, Lloyds and Barclays have all performed considerably better than that, now might be a good time to switch out of UK financials and into PCFT.

Moving away from bank stocks

PCFT managers Nick Brind and George Barrow have significantly reduced their exposure to banks in the recent years – their allocation to the sector was 59% of the portfolio three years ago and 49% two years ago. “Some banks are great businesses,” says Brind, “but we see better opportunities elsewhere.”

“The sector has performed very well and valuations have risen but earnings have grown faster than the market,” he says. “When we started, 12 years ago, the sector was trading on a 15% discount to the broader market; now it’s on 12 times earnings or 11 times excluding the data-service companies such as Visa and Mastercard. This is a 30% discount to the market.”

Financials have been widely distrusted by investors since the 2008 financial crisis, but “banks have been forced to clean up their act, and a lot of risk has been shifted off-balance sheet. The financial system has much more capital and liquidity, household and corporate balance sheets have seen a significant strengthening, yet the sector remains unloved.”

The sector would benefit from lower interest rates and lighter-touch regulation in the US and Europe. “We believe it would take a severely negative macroeconomic scenario to end the sector’s relative outperformance,” says Brind.

PCFT is trading at a 5% discount to net asset value (NAV). It offers the chance to redeem at NAV every five years, and the latest redemption cut the market cap by more than 40% to £350 million. Fees have been reduced, and a revised dividend policy pays 4% of NAV yearly.

An equally compelling investment worth considering is Polar Capital’s Global Insurance Fund, which has returned 98% over five years and 223% over 10.

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After a couple of decades in the doldrums, UK banks have performed well over the past 18 months. The FTSE 350 Banks index is up by 70% since the start of 2024, outperforming both the Nasdaq (up 35%) and the S&P Regional Banks index in the US (up 12%).

When it comes to investing in banks, common-sense “buy and hold” investing rarely works: HSBC and Standard Chartered – the best performers over the past 20 years – have seen their share prices fail to keep pace with inflation, while diluting shareholders with capital raisings over the years. A counterintuitive approach has produced superior results: wait until the whole sector’s fortune has turned and then buy the lowest-quality banks. We have seen the same outcome this time: it is Metro Bank (up 196%) and NatWest (up 147%) that have been the best performers.

Two headwinds that UK banks have faced ever since the crisis have now reversed: loss-absorbing equity funding has been restored, while interest rates have risen well above post-crisis lows. Low interest rates are normally seen as a positive for banks, but when the cost of money falls too low, the banks’ “free float” from current account deposits – a reliable and cheap source of funding – don’t enjoy any relative advantage versus funding in wholesale debt markets.

Of course, if UK banks had not lent out so much money in the first place that interest rates needed to be cut below 1%, then they wouldn’t have had to spend the last decade and a half managing the problems caused by low interest rates. However, with the interest-rate cycle returning to more normal levels and equity cushions rebuilt, banks have re-rated from trading at 25%-50% discounts to tangible book value (TBV) to roughly 1.1 times TBV currently.

The banking environment is benign enough that we may even have an initial public offering (IPO) from Shawbrook, a small business lender owned by private equity groups BC Partners and Pollen Street Capital. Shawbrook may float later this year and is targeting a £2 billion valuation. However, that valuation looks ambitious given the performance of past IPOs such as Metro Bank, Funding Circle and CAB Payments, which all fell by more than 80%. These investments did very well for early investors who got in before they listed and received a windfall gain at the expense of public-market investors. Anybody buying into the Shawbrook IPO would need to be sure that sellers are not timing their sale to exit just before problems emerge.

UK bank stocks

Still, even as the environment has improved, questions remain about the long-term growth prospects for UK banks. Household debt – mainly mortgages – currently stands at about 80% of GDP in the UK, above the level seen in the USA and the European Union (although the latter shows wide dispersion, with some countries such as the Netherlands and Denmark approaching household debt close to 100% of GDP). We are close to the limit as to how much household and government debt the banking system can support, which limits domestic growth opportunities.

From 2004 to 2024, Lloyds doubled revenue to £18 billion, yet book value per share shrunk by half to 75p. That’s mainly a result of the ill-conceived “rescue” merger with HBOS in 2008, which at the time had a balance sheet twice the size of Lloyds'. Barclays has grown revenue by 40% to £21 billion over the same period, while book value per share doubled to £5 as of December 2024. Yet earnings per share (EPS) are still down by a third to 35p. The only UK clearing bank to grow revenue, book value and EPS over that time is HSBC. Still, an increase in revenue of 21% and NAV per share up by less than 80% equates to compound annual growth rates of less than 1% for revenue and under 3% for NAV.

Bank stocks in small territories

Growth for UK banks could come from overseas expansion, but here the record is mixed. Bankers, being dull and unimaginative people, like to expand their footprint into countries with large populations, but it has been small, fast-growing territories with strong institutions such as Hong Kong and Singapore that have most rewarded investors.

HSBC (formerly the Hong Kong and Shanghai Banking Corporation), market cap £170 billion, and Singapore’s DBS, market cap £83 billion, have long since outgrown their city-state roots. Although less familiar to most UK investors, DBS’s track record is more impressive than HSBC’s. It is three times the size of Bank Rakyat (market cap £27 billion), the largest bank in Indonesia, which has almost 50 times the population of Singapore. It is also around four times the size of Maybank (market cap £20 billion) in neighbouring Malaysia, which has six times the population.

A large amount of credit for the far greater success of DBS and its peers OCBC and UOB relative to regional neighbours goes back to the Singapore’s first prime minister Lee Kuan Yew, who transformed the country from a swamp to a first world economy, with the help of air conditioning and British institutions. The crucial lesson that while banks are intrinsically linked to their domestic economies, it is strong institutions rather than a large population that make for an attractive investment case.

A bank that didn’t learn – and one that did

In recent years, HSBC has been shrinking its global network as it became obvious even to management that the bloated corporation with 9,800 offices in 77 countries and 243,000 staff was suffering from diseconomies of scale. The most recent annual report says it has trimmed that number down to 58 countries and 211,000 staff. Shrinking a global business is much more challenging than growing. HSBC has exited countries such as Canada, Brazil, Argentina and France, often ignominiously.

It was easy for HSBC to expand into France originally, points out Marc Rubinstein, a former hedge fund manager turned financial blogger – the bank simply offered to pay more than rival bidders to acquire Crédit Commercial de France (CCF) in 2000. Twenty years later, HSBC struggled to find anybody to take CCF off its hands. Private-equity firm Cerberus paid HSBC a single euro to assume $2 billion of tangible book capital, together with 244 branches and nearly 4,000 staff. HSBC booked a $2.3 billion pre-tax loss, alongside a $700 million goodwill impairment charge. Now, a new threat has emerged. App-based banking and payments firm Revolut currently has 52.5 million customers – of whom 14.5 million joined over the past year – compared with HSBC’s 41 million. It is licensed in 30 countries, including Brazil and Mexico, and in 2024 submitted 10 new licences to banking regulators as it works towards a target of 100 million customers across 100 countries. UK-based rivals Monzo, Starling and Atom Bank and others such as N26 (Germany) and Nubank (Brazil) are also threatening traditional branch-based banks.

These neobanks operate with structurally lower costs: Revolut has just over 10,000 staff – that’s 5% of HSBC’s total, despite having more customers. Revolut grew customer balances by 66% to £30 billion, while Monzo saw deposits up 48% to £16.6 billion. While HSBC has $1.65 trillion in customer deposits, that amount has shrunk from the 2021 level. These new entrants are now radically upending how we think about the investment case in banks. Yet perhaps DBS is a case study on how incumbents can respond to disruption.

DBS has won awards for “World’s Best Bank” from Global Finance and Euromoney, and been voted “Global Bank of the Year” by The Banker. More concretely, it has increased revenues fivefold over the past 20 years in US dollar terms – far ahead of HSBC. TBV per share is also up five times in US dollars, and the shares now trade on a multiple of almost 2.1 times.

Much of this success can be attributed to Piyush Gupta, the former chief executive who ran DBS for 16 years before retiring this year. After a meeting in 2014 with Jack Ma, the founder of Chinese tech giant Alibaba, DBS began its digitisation strategy. Staff were encouraged to learn from tech companies, asking not “what would Jamie Dimon do?” but “what would Jeff Bezos do?”. The bank has expanded via strategic deals in Asia, buying Citigroup’s Taiwan consumer unit and transforming its small operation in India by buying Lakshmi Vilas Bank when the latter failed in 2020.

DBS now has 18.4 million customers, up from 4.9 million a decade ago. The market cap of £83 billion implies that each customer is now worth just under £4,700, compared with just £1,800 for Lloyds Bank. So it now looks fully valued. Still, investors looking for banks with strong growth prospects could take on board the lesson of looking for well-run banks in small markets that can expand shrewdly.

Bank stocks in Georgia

Take Tbilisi-based Lion Finance (LSE: BGEO) – previously known as Bank of Georgia – which is listed in London and part of the FTSE 350 banks index. It has grown revenue in US dollar terms by 58 times to $1.3 billion over the past 20 years. Book value per share is up 18 times. I last wrote about Lion Finance in April 2022 when the share price was £12. Today, it is £80.

At the start of 2024, the group has bought an Armenian bank for $300 million. That price equates to just 0.65 times historic book value or 2.6 times 2023 earnings. When questioned about this attractive valuation, management pointed out that there simply weren’t many buyers able to write a cheque for $300 million to buy an Armenian bank. At the end of July, Lion Finance confirmed press speculation that it is in talks to buy a 70% stake in HSBC’s Malta operations (Ardshinbank, an Armenian bank owned by billionaire Karen Safaryan, who made his money in Russia in the 1990s, is also in the running for this deal).

Of course, Singapore is one of the wealthiest countries in the world, with GDP per capita of roughly $90,000 in nominal terms, while Georgia and Armenia both have GDP per capita of under $10,000. DBS is 14 times larger than Lion Finance by revenue and 23 times larger by market capitalisation. However, Georgia and Armenia are on the right path, with the IMF forecasting growth of about 5% a year out to 2030. The main risk to the investment case in Georgian banks is not growth, but failing institutions. Russian president Vladimir Putin considers Georgia to fall within his “sphere of influence” and Bidzina Ivanishvili, the former prime minister and still de facto leader of Georgia, could be forced to degrade the rule of law and press freedom to please his bellicose northern neighbour.

This fear explains the “geographic discount” – the low valuations that the Georgian banks trade at relative to their obvious potential. Lion Finance and its competitor TBC Bank trade on around 1.9 times last year’s TBV – a premium to their UK-based peers, but still a substantial discount to pre-credit crisis levels. However, Lion Finance is forecast to grow revenue and earnings at 15% this year. The shares continue to look attractive despite the risks, trading on just five times forecast earnings for 2026 and 1.3 times forecast TBV. I remain invested.

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It’s difficult to imagine a time when anybody was more bullish on Europe than America, but this was a popular investment thesis before the global financial crisis. The US had a giant housing bubble, a vast trade deficit and a currency in steady decline. Consumers were heavily dependent on spending their savings, according to statistics at the time (this data later got revised, and those eight quarters with a negative savings rate turned out to be an error – a good example of how unreliable statistics can be, as I discussed last week). Europe also had housing bubbles, but otherwise looked sounder and was well placed to benefit from emerging market growth.

We all know how this theory turned out. Europe has trailed the US on virtually every financial measure since the crisis (one can very fairly argue that Europe still offers a better quality of life in many ways, but that’s not what we are looking at). The reasons for this go beyond the idea that America is simply more innovative and dynamic, with a whole series of events working against Europe or for the US.

The eurozone debt crisis dragged on far too long, with far too much can-kicking. The shale revolution created a huge advantage for US growth and for the trade balance. Regardless of one’s views on Brexit itself, most people would acknowledge that the process was a distracting, exhausting upheaval for both Britain and the EU. Most recently, Russia’s invasion of Ukraine turned an energy disadvantage into a crisis, put a full-scale war on the borders of a continent that was complacent and completely unprepared for it, and sent uncertainty and fear rocketing. Look back at all this and maybe we should be amazed that Europe hasn’t done even worse.

Still, it didn’t help that Europe put its head in the sand much more than America when cleaning up its banks after the crisis. US policymakers did not exactly get this right – banks were bailed out too freely, there was no accountability for the actions that led to the crisis, and interest rates were cut too low and stayed there too long. Yet its bank stress tests were a success: they led to clear recapitalisation plans, restored confidence in the sector and left banks able to lend again.

European banks stocks are accelerating

Europe’s stress tests were a fudge, and markets knew it. Banks were not recapitalised quickly: they only gradually recognised bad debts while they rebuilt capital. Ultra-low interest rates hurt profitability and made this process slow. That meant that they were in a weak position to lend, even if demand was there. So, US bank shares far outstripped European ones for the next decade.

Yet on the eve of the pandemic, European banks were finally in better shape. After shares bottomed in April 2020, they began to rally. Since 2023, they have beaten US banks and are accelerating. Valuations are rising: the Euro Stoxx Banks index is on a price/book of 1.1, up from 0.7 two years ago. Banks are highly cyclical, and I never like the sector, but they are central to the economy. If Europe is to regain ground against the US this decade, they should have further to run over the long term.

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Shares in Close Brothers were up by 20% on Monday. Lloyds was up by almost 8%. The rest of the banking sector was rising, too, as shareholders celebrated the decision by the Supreme Court that some of the wilder claims over mis-selling of motor finance should be thrown out.

It was a rare example of common sense from a body that, in its short life, has rarely shown any inclination to take the side of business. After the market closed last Friday, it rejected the bulk of the claims that millions of car-finance packages had been mis-sold because commissions paid to dealers and other middlemen had not been properly disclosed.

Car finance mis-selling decision

The judges decided, quite sensibly, that the motor trade has, to put it mildly, always been known for sharp practice, and anyone taking out a loan to buy a car should have checked the small print before signing on the dotted line. Given that the total bill for compensation could have run to £40 billion or more if earlier rulings in favour of the claims by the High Court had been upheld, it’s not hard to see why the City was pleased.

There’s just one catch. The Financial Conduct Authority is now proposing a more limited scheme that will compensate customers for commissions that were excessively high. It will pay out on average £950 to each driver, at a total cost to the banking system of between £9 billion and £18 billion. There is still going to be a huge bill for the banks and finance houses involved.

There are two even bigger problems. First, it will be yet another blow to the reputation of the banks. There have already been more than £50 billion in payouts from the mis-selling of personal protection plans on mortgages, and plenty of smaller examples where the main banks have been forced to pay compensation for both personal and small-business products where terms and conditions were not properly disclosed.

The car-finance scandal comes on top of more than 15 years where just about any product more complex than a current account sold by one of the major high street banks has turned out to be dodgy in one way or another. The banks are already facing huge challenges from the rise of new, app-based rivals that have better technology and are not burdened by the cost of hundreds of branches, and typically have far better reputations. If several million motorists are offered payouts for car-finance claims, it will only encourage the belief that everything the banks sell is some form of scam. It is hard to see how any business can thrive in the long term if its customers no longer trust it.

US-style mass consumer litigation

Next, it will only encourage yet more mass claims. It might have been hoped that the Supreme Court ruling would stop the trend towards class actions that has taken root in the British legal system. But if the regulator hands out £10 billion or more in payments, the claims-management industry – which, if we are being honest, probably has even more questionable standards than car finance – will be given yet another huge boost.

The UK is on a worrying path where we develop US-style mass consumer litigation – with all the costs and uncertainties that creates for business – but without US levels of productivity and innovation to make up for it. It is the worst of all possible worlds.

Any global investor looking at a British bank right now will conclude that, with a stagnant economy, there will be very little profit growth, and that it may well be stung for a few billion in compensation payments at any moment. It’s not a very attractive mix, and one that will make it harder to revive the fortunes of the City. In reality, there is almost no form of financial service that doesn’t involve some small print and commissions somewhere along the line. It will always be possible for law firms to argue that the terms were not properly disclosed, that customers didn’t know what they were signing, and that the commissions were too generous.

If the banks have to pay out over this, they will have to pay out again and again, until the whole industry is no longer viable. It would have been far better to stop the litigation when the Supreme Court threw out the bulk of the claims – and give the City a chance to recover instead.

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UK equities are having their time in the sun. The FTSE 100 recently hit an all-time high of 9,000, driven by a broad recovery in equity prices. To put it another way, the rally wasn’t just driven by a handful of outperformers. In fact, during the first half of the year, UK equities have done better than their US peers, reversing a decade-long trend of US outperformance. Since the start of 2025, the FTSE All-Share has delivered a total return of just over 9% in local currency terms. In US dollar terms, it produced a total return of 19%, significantly outperforming the S&P 500’s 6%.

According to numbers compiled by the wealth-management giant Schroders, the outperformance has been driven not by earnings growth, but by multiple expansion – a side effect of investors’ confidence improving. Over the first half, Schroders calculated the UK’s total return was driven by a 10% increase in valuation and a 2% return from dividends. Earnings, on the other hand, proved to be a headwind, taking 3% off returns as analysts pushed growth projections lower due to global uncertainty (mainly over tariffs).

UK equities: a growth story

Sentiment counts for a lot in markets and in the UK that has improved dramatically (albeit from a very low base) over the past six to 12 months. It might not seem like it, but the UK has experienced the strongest run of positive economic surprises among developed markets since January. According to Citi’s Economic Surprise Index (once again, from a very low base), sentiment around the UK’s trade-deal “hat trick” with the US, India and the EU seemed to reignite investors’ sentiment about growth. There’s also the tailwind of interest rates. Markets are pricing in several rate cuts by the Bank of England over the remainder of the year and into 2026. Lower rates should support domestic cyclical stocks such as retailers, housebuilders and builders’ merchants. These rate-sensitive sectors should also benefit as Labour’s efforts to drive investment in infrastructure and planning reforms start to yield results.

Despite the market’s strong performance so far this year, investors, particularly those in the UK, are still leaving in droves. According to equity fund flow data compiled by JPMorgan, over the last 12 months, around £32 billion has flowed out of UK equity funds, equivalent to 11.6% of starting assets under management. Investors seem to be selling into the rally, with outflows accelerating over the past few months despite recent market highs.

It might come as a surprise, but on a top-down basis, UK equities are a growth story. Estimates from JPMorgan have earnings per share in the FTSE 100 growing by 11.5% in 2025, before falling back to 2.5% in 2026. Schroder’s Intelligence, on the other hand, has earnings per share growing 3% this year and then 12% in 2026. Whichever way you look at it, that’s projected earnings growth in the mid-teens over the next two years. Based on that, the FTSE 100 is trading at an average forward price-earnings (p/e) ratio of 12. “This represents a 10%-15% discount to their 15-year medians and a substantial discount compared with the US market,” according to JPMorgan.

Dig deeper, and the valuation is even more compelling. “UK mid-caps trade at 12 times expected 2025 earnings, with earnings forecast to grow at around 15% year-on-year, indicating potential good value (a p/e ratio less than the growth rate). There’s potential for a re-rating if domestic growth persists,” the investment bank adds.

UK equities: key risks to avoid

There are compelling reasons to buy UK equities, but there are also plenty of risks to consider. JPMorgan makes it clear that domestic stocks are favoured over international exporters. Over the past four years, industrial energy prices in the UK have risen to the highest levels in the developed world, making it difficult for most producers to compete with their international counterparts. A significant portion of the UK’s industrial base has vanished as a result. It doesn’t look like this environment is going to change anytime soon.

Utilities also look risky due to political interference, high capital spending requirements and generally poor return profiles. Indebted consumer stocks, which will suffer if wage growth stagnates, should also be avoided. The major lingering risk for UK equities is the potential for further tax rises. The Labour government has been floating numerous potential tax hikes in the autumn Budget. With the country’s finances deteriorating and a complete lack of political will to cut spending, additional taxes are almost guaranteed. Additional taxes will have an impact on consumer spending and business activity. Based on the last round of tax hikes, which dented business confidence and squeezed hiring, investors do need to consider this risk on the horizon.

The valuation of UK equities compared with international peers has already led to a wave of takeover offers. As UK investors flee, international investors are seizing the opportunity to swoop in. The value is there, and private equity is capitalising on it. Real estate investment trusts (Reits) have become a particular area of interest. Assura, Urban Logistics, Care Reit and Warehouse Reit have all been acquired this year. Due to an interesting quirk in the law regarding stamp duty, it is often cheaper to purchase property through a company structure than to buy it directly. Shares attract stamp duty at a rate of only 0.5%, while corporate bodies buying certain types of property may face stamp-duty rates in the mid-teens. So, acquirers receive a tax benefit, as well as the opportunity to purchase property at a discount to its market rate. At the beginning of June, there had been more than 30 bids for companies worth more than £100 million, with an average premium of 45% across all sectors.

Aside from the real-estate sector, high-quality UK mid caps and small caps look attractive, trading at historically wide discounts to their US peers and with international revenue footprints. Banks offer dividend yields in the mid single digits with further capital returns likely as profits continue to grow and are still trading at relatively low valuations despite their shares rising to levels not seen since before the financial crisis.

UK equities: go for quality

So where should investors be looking for value? As ever, quality is key. A fascinating study on this topic emerged at the beginning of July in the form of a Panmure Liberum report, “Accounting red flags: high-quality stocks lead”. The research, building on academic studies and machine-learning applications, aims to help investors identify high-quality stocks, avoid corporate failures and enhance returns. The framework focuses on three main areas: accounting quality, audit risk and governance oversight. Companies were categorised into the top 30% (highest accounting quality) and the bottom 30% (lowest accounting quality) baskets (excluding financial and real estate companies due to issues arising from leverage). Over the past five years (ending June 2025), the report found that the top 30% quality basket in the UK outperformed the bottom 30% by an annualised 9%.

After analysing the data on reports from 2024, the analysts compiled a select list of UK equities that they believed met all the criteria they were looking for in terms of companies with the best-quality accounts. The list includes the likes of Associated British Foods, BT Group, DCC, Games Workshop Group, Halma, Mitchells & Butlers, National Grid, J. Sainsbury, SSE, Taylor Wimpey and Whitbread.

UK equities: promising healthcare champions

Panmure Liberum has also dived into the healthcare sector in the UK. Healthcare, biotechnology and pharmaceuticals are all areas of strength in the UK economy. They are among the most significant growth sectors globally, given the ageing population, advancements in medical technology and increasing wealth. Advanced Medical Solutions (LSE: AMS) sits in the sweet spot of UK value and is one of Panmure Liberum’s favourite plays. The company has a portfolio of “medtech” products, mostly developed in-house, focused on the surgical and wound-care markets. It was a small-cap champion and returned more than 1,000% between 2010 and mid-2018. However, the business struggled to grow into its valuation, and the stock is down around 30% over the past five years. Still, Panmure thinks this is the “best rerating story” in the medtech sector and looks “most obviously oversold” when compared with historic ratings. The company has made several strategic missteps over the past five years, which have hindered growth in the US market. Difficulty digesting a recent acquisition has also spooked investors. But while the market struggles to understand the business, private equity is waiting in the wings. A recent approach from Montagu didn’t generate an offer, but it put the company on investors’ radars. Panmure believes a fair price for the company is between 300p and 350p.

The investment bank also thinks animal genetics company Genus (LSE: GNS) is deeply undervalued. The company specialises in using cutting-edge science and technology, including genomics selection and gene editing, to enhance animal breeding. For example, in April, Genus received US regulatory approval for its product designed to provide pigs with resistance to porcine reproductive and respiratory syndrome (PRRS), a disease affecting farmers worldwide. This was a “hugely significant landmark” and is expected to lead to approvals in other jurisdictions. This treatment alone could be worth more than 1,000p per share, but much of the growth isn’t yet reflected in the company’s share price.

A wild card is CVS Group (LSE: CVSG). Investors dumped shares in the group, which owns veterinary practices across the country, when the UK regulator announced an investigation into market and pricing practices in May 2024. As investors have reevaluated their position, the stock has recovered and Panmure sees further upside. It notes that the regulator’s working paper on remedies was “relatively benign”. Initial findings are expected in September 2025, and final recommendations before January/February 2026. If the outcome of the investigation comes out as expected, analysts believe the stock could be worth around 1,600p based on historic profit multiples.

UK equities: mid caps

Berenberg has also highlighted some of the most attractive names in the UK mid-cap sector based on their growth potential. Genus is on their list, as well as electronics retailer Currys (LSE: CURY). At the beginning of the month, the company reported a 37% increase in adjusted profit before tax, along with the return of cash dividends, as the group’s cash balance rose to £180 million net at the end of the year. However, the stock is trading at a forward p/e below ten, which does not seem to consider the company’s growth potential. OSB Group (LSE: OSB) and Paragon Banking (LSE: PAG), two specialist mid-cap lenders, are also on the investment bank’s list of undervalued growth plays. The former is trading on a p/e of 4.8, while the latter is on 7.1 times forward earnings. Both have carved out a niche in the buy-to-let lending market, which, despite negative headlines, is still growing. Paragon recorded a 25% rise in new buy-to-let lending in the first half of its financial year, driven by growing demand from landlords, the firm announced at the beginning of June. OSB has had to deal with internal issues as well over the past few years, but these now seem to be behind the business. A series of updates providing evidence that the firm is delivering in the short-term will “help restore confidence”, noted Panmure in a recent note.

Other mid caps on Berenberg’s radar, all trading on a p/e of ten or less, include Kier Group (LSE: KIE), ITV (LSE: ITV), Mitie (LSE: MTO), Pets at Home (LSE: PETS) and IG Group (LSE: IGG). Kier and Mitie, in particular, are plays on the UK government’s ballooning spending bill; ITV is more of a break-up/ takeover play. IG, with its firm and growing foothold in global financial markets, is a true UK-based global champion, with a substantial growth runway ahead. One company that features on a lot of “best-buy” lists issued by the City’s top brokers is Babcock International (LSE: BAB). The defence firm is one of the major contractors for the UK’s nuclear deterrent, and the shares have more than doubled in value over the past year as the Labour government has reiterated its commitment to defence spending in the UK. The shares started the year at a discounted multiple of just 10.4 times forward earnings. Now, they’re closer to 20 times, which is a bit on the pricey side. That said, defence is a long-run, predictable business, suggesting Babcock deserves a premium valuation. JPMorgan has earnings growing 64% in 2025 and then 8% in 2026, with a 4.2% dividend yield.

Barclays’ favourite mid-cap is 4imprint Group (LSE: FOUR). The firm, which produces promotional products, is one of the investment bank’s top picks in Europe, with a potential upside of 68% to the 5,500p price target and a Barclays “quality” rating of 99%. The quality of the business is determined by its strong net cash balance (£148 million at the end of 2024), free cash flow (£103 million estimated for 2025) and return on capital employed of 77.7% in 2024. Despite these metrics, the stock is trading at an undemanding forward p/e of 12.7, with a prospective dividend yield of 5.1%.

UK equities: the best of the best

There are plenty of London-listed mid caps that look attractive at current valuations, but which ones really deserve a place in your portfolio? 4imprint seems to be one of the City’s top picks. Barclays has it as one of its top plays in Europe, and it’s one of a handful of businesses with net cash on the balance sheet. Berenberg thinks “4imprint’s highly cash-generative model and low appetite” for mergers and acquisitions suggests there is “scope for increased returns to shareholders through special dividends or buybacks”. It also thinks there’s plenty of scope for the group to expand its profit margins through economies of scale and general growth.

Genus is another firm that is universally backed by the City.

Deutsche Bank, Berenberg and Panmure have all flagged the stock as a “buy” following its winning US regulatory approval and due to rising demand for animal proteins. Babcock also has a strong following. It’s those long contract lead times that are really exciting. Berenberg puts it nicely: “Revenue guidance strikes us as conservative given the large pipeline of domestic and international defence contract opportunities, as well as the strong momentum as evidenced by the 11% average annual organic revenue growth achieved in the last three years”.

In the property sector, NewRiver REIT (LSE: NRR) has been flagged as an undervalued recovery play. As an owner of retail parks and shopping centres, NewRiver has faced a challenging few years, but the outlook is now starting to improve. “With rents still affordable and asset values near cyclical lows,” NewRiver’s portfolio is well placed to benefit from the normalisation in investors’ sentiment “and the hunt for high, stable income”, Panmure Liberum’s property team notes. The 9.1% dividend yield is fully covered and the company is trading at a 36% discount to the value of its net assets – appealing as bidders circle the sector.

Finally, there’s Mr Kipling owner Premier Food (LSE: PFD). This company has risen, like a phoenix from the ashes, over the past five years. Coming out of the pandemic, the group was overleveraged, burdened by onerous pension obligations and struggling to control a bloated cost base. It soon got costs under control, but debt and pensions remained an issue. In the past three years, it’s been able to draw a line under the pension issues and make a dent in the debt. It’s used the cash to reinvest in the business, reinstate the dividend, and is now looking for acquisition deals. After a strong few years, analysts weren’t expecting much in the way of excitement this year. They were wrong. A recent trading update beat low expectations and management reaffirmed profit expectations for the year. Growth will be driven by progress in new products and recent acquisitions. Both Shore Capital and Berenberg analysts tip the stock. It trades on a forward p/e of 13, compared with the peer group average of 17.

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Murray International Trust is a globally diversified investment trust aiming to deliver an attractive and growing income, alongside long-term capital growth. By investing in companies with sustainable and rising cash flows, the fund avoids overexposure to low-yielding stocks, making it a distinctive complement to more growth-focused global funds.

Recognised as a “dividend hero” by the Association of Investment Companies (AIC), Murray International has increased its dividend for 20 consecutive years. It is managed by an experienced team at Aberdeen who have worked together for over two decades and is supported by researchers posted to key developed and emerging markets, helping to uncover high-quality opportunities wherever they arise.

Global stocks banking on growth

Intesa Sanpaolo (Milan: ISP), Italy’s biggest domestic bank, offers a wide range of services across retail, corporate and investment banking; wealth management and insurance. The management has delivered strong operational efficiency, with a cost-to-income ratio of 38% in the first quarter of 2025 – among the lowest levels in Europe.

A strategic focus on higher-return, higher-growth areas, such as wealth and savings, bodes well. Management has repeatedly raised guidance and remains optimistic, with falling interest rates providing a supportive backdrop. We initiated a position in early April, taking advantage of fears of a global recession and market weakness around “Liberation Day”. The stock has since performed well, but we continue to view it as a quality compounder. Its robust capital position, moreover, supports a premium 7% dividend yield, further adding to its appeal.

Diageo (LSE: DGE) is a leading UK-based alcoholic beverages company and one of the world’s largest producers of spirits, with a portfolio of iconic brands, including Johnnie Walker, Talisker, Smirnoff, Tanqueray, Don Julio, Casamigos and Guinness. Since 2022, the company has faced multiple challenges: excessive inventory, operational mis-steps, weaker demand from consumers, the threat of rising tariffs and shifting drinking habits, all of which led to a halving of the share price following a post-Covid boom.

There has been much debate about whether these headwinds are structural or cyclical in nature, alongside scrutiny of the management team. After careful consideration, we added to the trust’s holding. While further patience may be required, we believe Diageo’s global presence, strong brand and breadth, together with its ability to innovate, will deliver long-term value.

Infosys (Mumbai: INFY) is a global IT services and consulting company with headquarters in India. It offers services such as cloud computing; AI and automation; data analytics; cybersecurity; and digital transformation across industries, including finance, healthcare, retail and manufacturing.

The share price has underperformed this year as macroeconomic uncertainty has prompted clients to delay discretionary projects. But the management team recently confirmed that the pipeline for cost-reduction programmes remains robust, and this is an area of expertise for Infosys. We see real potential in the company’s expansion into AI-related services and believe the current share price presents an attractive entry point for long-term investors.

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NatWest chief executive Paul Thwaite says the bank is likely to return to full private ownership next year.

Speaking at an FT event in London on Tuesday, he said: “It is reasonable to expect that absent some big dislocation or economic event we’ll be back in private ownership next year, maybe as early as the first half of the year.”

It comes less than two weeks after NatWest bought back £1 billion of shares from the Treasury in November.

The UK government’s stake in NatWest is now below 11%. At one stage, the bank was 84% owned by the state after a £46 billion bailout at the height of the financial crisis.

Thwaite said at the time of the November buy-back: “As a result of NatWest group’s continued strong performance, we are pleased to have today completed our second buy-back of government shares of 2024, further reducing HM Treasury’s shareholding."

That transactions meant NatWest continues to edge closer to full privatisation and comes after chancellor Rachel Reeves abandoned plans to sell the government’s remaining stake in NatWest to the public.

What is happening with NatWest’s share price?

The bank’s share price has almost doubled over the past 12 months. At the end of October, it rose by just shy of 5% on the day it revealed its operating profits were £200 million higher than expected during the third quarter.

The banking group said it made an operating pre-tax profit of £1.7 billion between July and September 2024, nearly a third higher than the £1.3 billion generated during the same period last year. Analysts were forecasting profits of £1.5 billion.

The increase was partly driven by an increase in lending and the amount of money customers deposited with the bank.

The results sent shares in the bank to their highest levels since 2015.

Thwaite said at the time: “The strength of NatWest Group’s performance is underpinned by the support we provide to our 19 million customers in every nation and region of the UK.

“Throughout the third quarter of 2024, we have grown our lending, helping customers to buy or remortgage their homes or to start and grow their businesses. With customer activity increasing… and defaults remaining low, we are well placed to succeed with our customers and for our shareholders in the months and years ahead.”

Why did NatWest ditch its public share sale?

Reeves abandoned plans to sell the government’s remaining stake in NatWest to the public in July, saying it would not “represent value for money”.

The Labour chancellor said that a retail share sale of the bank would now not happen as it would have meant having to offer the public discounts worth hundreds of millions of pounds, which would be damaging for taxpayers.

A public sale would "not represent value for money, and it will not go ahead", Reeves told MPs as part of a statement on public finances. She added: “It’s a bad use of taxpayer money and we will not do it."

Sarah Coles, head of personal finance at Hargreaves Lansdown, said at the time: “The news that retail investors will be frozen out as NatWest shares are sold off is bitterly disappointing. Retail investors are all too often overlooked and yet they are important backers of UK companies, holding a greater proportion of their assets in the UK compared to the likes of pension funds.”

HSBC’s shares bounced this week after the latest results showed the bank had lifted pre-tax profits by 11% in the third quarter, “significantly beating downbeat expectations”, says Patrick Hosking in The Times. The bank said this was due to “strong performances in wealth, personal banking and parts of the investment banking division”. HSBC also promised a further $4.8 billion in distributions to shareholders through buybacks and dividends. CEO Georges Elhedery reaffirmed his plans to winnow out senior ranks of the bank “at pace”, though he “emphatically” ruled out any break-up of the group.

HSBC’s latest good results have certainly cheered shareholders, say Selena Li and Lawrence White on Reuters – the shares are now at a six-year high. However, experts still warn HSBC still “needs to explain more about the financial implications of its overhaul”, which involves merging divisions as well as dividing management along East-West lines. Elhedery has declined to comment on how much the revamp will save the bank in costs, or how many senior roles may be cut. Instead, he argues that any cost savings will be an “ancillary benefit” from simplifying the management of the bank and removing duplication of roles.

Elhedery is right to be cautious about costs, says Lex in the Financial Times. Any saving from cutting HSBC’s “expensive layer of senior bankers” is going to be limited. Even the purported figure of $300 million looks small in comparison to the $3.8 billion of bonuses it handed out in 2023. Similarly, while separating Asian from Western operations may sound logical, a large chunk of the money it makes in the region “comes from deals that originate overseas from international clients”. Overall, there is a very real risk that Elhedery’s plans end up being one of those “grand global restructuring announcements” that HSBC has made many times before.

What is the state of Britain's other banks?

It’s been a “pretty decent earnings season all round” for the UK banking sector, says AJ Bell’s Russ Mould. NatWest, Lloyds and Barclays all revealed unexpectedly high profits, too. Considering the tougher environment of “falling interest rates and softening economic growth”, shareholders should be “more than satisfied”. Meanwhile, “the absence of any signs of stress among their core customer base” also bodes well.

Perhaps the only cloud on the horizon is the Court of Appeal’s ruling in favour of a claimant who sued Close Brothers over the failure to disclose commissions paid to car deals for car loans, says Hargreaves Lansdown’s Matt Britzman. This suggests that the Financial Conduct Authority (FCA), the City regulator, could take a “harsher view” in its wider investigation into motor finance commissions. If upheld, the verdict would hit Lloyds particularly hard, with a total liability of up to £2 billion, though even then the broader Lloyds investment case “looks solid”.

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Preparations are at an “advanced stage” for HSBC, one of the world’s biggest lenders, to try again to bolt together its commercial banking division with its global banking and markets unit. The revamp could lead to hundreds of job losses in senior ranks, says Patrick Hosking in The Times. 

While HSBC attempted a partial merger of the two divisions in 2020, it had to abandon the effort because of Covid. However, as its shares have greatly lagged its peers in the past nine months, it will restart the plans in the hope of saving up to $300 million. The move may help placate those who have grown frustrated with what they see as the “slow pace of cuts”, says Lex in the Financial Times. It also makes sense to focus on senior management as “that’s where the costs are”.

But the hoped-for $300 million in savings will amount to 1% of the total $32 billion in costs the bank reported last year. This is because a lot of the back-office functions are already consolidated between the two units. To put this into context, costs soared by 12% in the commercial banking division in the first half of this year.

HSBC clearly suffers from “duplication across its different bits”, says Liam Proud for Breakingviews. Still, the merged entity would be opaque – investors could find it difficult “to get their heads around” the performance of a unit that offers everything from small-company banking to underwriting giant debt and equity offerings for multinationals.

A key task for HSBC

In any case, new CEO Georges Elhedery has a “much bigger job” than finding the “modest savings” he is reported to be eyeing up. A key task will be to find a way to grow the bank to make up for the loss in income from declining interest rates. Net interest income (the difference between what the bank makes from lending and what it pays out on savings) is projected to fall 7% this year and 2% next.

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The interest rate cycle has turned. On 1 August, the Bank of England cut the base rate from 5.25% to 5%. That should be good news for the banking sector, which is already up by 14% so far this year. 

Yet taking a longer-term perspective – and comparing the banks today with how they were in 2006, before the financial crisis – we can see that there’s still a problem: growth. HSBC, the largest UK-listed international bank, has seen revenue shrink by 9% to $63 billion. Barclays has done slightly better-growing revenue to £25 billion, but that only equates to a compound annual growth rate of just 1% over 17 years, well below the rate of inflation. Remember that these were the well-managed banks, who avoided calamitous acquisitions and didn’t need to be rescued by the UK taxpayer. Lloyds/HBOS has seen revenue shrink by 44% to £19 billion, and NatWest’s reported revenue is down by 47%. 

Software businesses such as Alphabet and Microsoft are classic examples of companies that need very little incremental capital to grow revenues. These firms have rewarded shareholders well over the long term. Banks have done the opposite. Revenue has been at best flat, if not shrinking, yet they have required substantially more equity funding just to tread water.

The recipe for cross-border banking growth

To find growth, we need to look to the unlisted sector. Since 2019, Revolut has grown its top line 11-fold to £1.8 billion. Monzo is up by 13 times to £690 million, while Atom is up by 100 times, although from a much lower base. In Revolut’s case, it is also impressive that this expansion has run across borders. 

Before the financial crisis, bank chief executives and corporate financiers spent a huge amount of time working on mostly unconsummated cross-border banking marriages. From their perspective at the top of large organisations, these deals made sense, but no one ever bothered to think about how this might benefit the long-suffering customers. After Fred Goodwin met his nemesis when he led RBS in a disastrous deal to buy ABN Amro, cross-border deals fell out of favour and banking empires are in decline. RBS, which was once the world’s biggest bank by total assets, is a shadow of its former self, with the overall group renamed NatWest to shed that history. HSBC has spent the past decade disposing of non-core operations, including exiting Argentina, Canada and French retail banking. Barclays has also spent years slimming down, including the sale of its Italian retail mortgage book in April and its German consumer finance business in July. 

Contrast that with Revolut, which has 45 million customers, of which just nine million are in the UK. Even before the UK regulator granted it a banking licence in July, its Lithuanian licence allowed it to take deposits across the 33 countries in the European Economic Area (EEA). It has also started taking deposits in Brazil and New Zealand and aims to expand aggressively in the US, where it already has nearly one million customers. Or for a different model, take Klarna, the Sweden-based buy-now pay-later fintech that wants to pivot into a payments platform and disrupt retail banking across 12 countries in Europe and the US.

How banks make higher returns

Ironically, unlike most start-ups that benefited from the easy-money era of low interest rates and central bank liquidity, fintechs didn’t. That’s because of a common misconception. Many people – including some professional fund managers – believe banks generate high returns from lending money. However, this assumption is demonstrably wrong. 

Lending money is a commodity business: borrowers can easily shop around for the best interest rate. Getting the lowest interest rate on mortgages is particularly important, as a few basis points could save thousands of pounds, or even tens of thousands, in interest over the 30-year life of the loan. A host of banks, including Santander, Lloyds, HSBC and NatWest, are once again offering UK mortgages for less than 4%. This suits the government, as politicians believe cheap mortgages are popular with voters. So banks are unlikely to make returns above their cost of equity on UK mortgages. 

Instead, banks make returns from the liability side of their balance sheet: customer deposits that provide cheap funding. Even now, with interest rates at 5%, around a third of NatWest’s customer deposits (£140 billion) are non-interest bearing. Having these accounts is a huge funding advantage relative to a non-bank lender such as Duke Capital, which lends to small businesses and pays sterling overnight index average (Sonia) plus 2% for its revolving credit facility. If Sonia ever fell back below 50 basis points, then the banks’ advantage of much lower funding costs would disappear again. 

So in a 5% interest-rate environment, banks enjoy an advantage versus non-bank lenders. That said, certain non-bank platforms, such as Hargreaves Lansdown and Wise, also benefit. Neither has a banking licence, but both companies are in the business of looking after customers’ money, which is placed in interest-bearing bank accounts. In the 2023 financial year, Hargreaves Lansdown earned £269 million from customers’ balances, while Wise earned £118 million – amounting to 67% and 80% of group profits respectively. Clients started to notice this, and so in the current year, both firms have had to share more interest with their account holders. 

Understanding how bank funding works explains why the easy-money era – in which companies such as Peloton, Zoom and the various flotsam and jetsam in Cathie Wood’s ARK Innovation fund briefly did very well – was not a great time to be a neo-bank. Many companies that promised profits in the distant future benefited from low interest rates, because investors discounted future profits at a very low discount rate, which made those future profits seem more valuable. On the other hand, banks and neo-banks struggled to make a profit in the low interest-rate environment, because every business had access to cheap funding.

A difficult era for fintechs

This meant, for instance, that Monzo struggled with bad debts before the pandemic and had to raise money from investors in 2020 at a 40% discount to its previous funding round, valuing it at just £1.25 billion. The decline in travel during the pandemic was devastating for Revolut’s core international payments business, while Wise also suffered losses due to unprecedented currency volatility in March 2020. Klarna also hit problems during the pandemic, and in 2022 it raised funds at a significantly reduced valuation of $6.5 billion, down from $45 billion in a previous funding round. 

In technology investing, venture capital backers are happy to fund years of losses as long as unit cost economics stack up and they can see a path to profitability as customer numbers and revenues grow. By contrast, investors in banks are rightly cautious about rapid growth in loan books and don’t reward growth with high price/earnings multiples. Before the financial crisis, Societe Generale hosted a “high-growth banks conference” where the banks presenting needed a five-year record of double-digit earnings growth to participate. Names such as Anglo Irish, Dexia, Fortis, Kaupthing and Northern Rock. None of those banks survived the financial crisis. 

Thus, one area where the traditional banks may yet win against the new entrants is credit quality and bad debts. Step back a couple of decades to when HBOS was aggressively growing its balance sheet and taking market share from more risk-averse banks, such as Lloyds. In meetings with investors, HBOS’s management were saying they planned to “wipe Lloyds off the face of the Earth”. The irony is that a few years later, they nearly achieved their aim – just not in the way they intended. Mere months after Lloyds took over HBOS in a reckless rescue deal agreed with the government, it had to be bailed out by the state after the assets it took on turned out to be even more toxic than expected.

Are neo-banks here to stay?

So how much are the neo-banks’ customers worth? In the UK, none of these firms has yet tested their private market valuations with a stock market listing. Starling is advertising for a head of investor relations, implying that it is looking to go public soon. Meanwhile, Revolut’s employees recently sold $500 million-worth of shares to existing investors at an implied valuation of $45 billion (£35 billion). That implies a similar market cap to Barclays and Lloyds, and 25% larger than NatWest. Valuations are wildly different. This would suggest a price-to-book multiple of 22, whereas listed UK banks have traded at discounts to book value since the financial crisis. 

Revolut has grown customer numbers rapidly to 45 million and shows no signs of slowing. Average annual revenues per customer are just £40, around one-third that of Wise and a quarter of Lloyd’s retail bank. So even with no further customer growth (unlikely), if Revolut can persuade users to keep higher balances on deposit and become their core banking relationship, that valuation begins to look less delusional. Combine that with international expansion into the Americas, where Brazil’s Nubank has a market cap of $70 billion and 105 million customers, and it could even make sense. 

On a market-cap-per-customer basis of £787, Revolut’s £35 billion valuation looks expensive, but not out of this world. Using a similar multiple would value Monzo at £7.6 billion and Starling at £3.3 billion. By comparison, Wise’s £6.5 billion market cap is £500 per customer, while the £5.4 billion buy-out of Hargreaves Lansdown by a private-equity consortium is at an implied value of £2,900 per customer, or 3.5 times higher. Still, a comparison with Hargreaves Lansdown shows that banking is not a licence to print money. Rather than lending, the neo-banks should be creating a platform to help customers with currencies, insurance and long-term savings to realise maximum value. 

However, some caution will probably be in order when these businesses come to market. Funding Circle, CAB Payments and Metro Bank have all been disastrous investments, with their share prices falling by around 90% since they listed. That’s because the stock market has become a mechanism for wealthy individuals, private equity and insiders to exit at the expense of investors, rather than raise capital for growth. Fund managers, who invest other people’s money, appear not to have noticed, but retail investors, who are looking after their own money, have. Many now avoid initial public offerings (IPOs), joking that IPO actually stands for “it’s probably overpriced”. 

Investors should also keep in mind a potential parallel with online UK fashion retailers. Firms such as Asos and Boohoo enjoyed considerable success in their early days, growing revenue and taking market share from high-street competitors such as French Connection, Ted Baker and Superdry. Yet Asos is now down from a peak valuation of £75 per share to below £4, and Boohoo has fallen 90% from its peak valuation. Much of that decline was caused by changes in customers’ behaviour (returning more clothes) and overseas competition, notably from Shein. 

In the online world, it is possible to expand rapidly by offering better value than bricks-and-mortar incumbents and even scale internationally across borders. Yet those strengths can become a weakness, as they make it hard to create a durable competitive advantage with loyal customers, as users are inclined to jump on to the latest trend.

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I recently attended the inaugural Weird Sh*t Investment Conference in London, organised by the legendary Swen Lorenz. I heard 25 presentations throughout the day, offering left-field investment ideas ranging from banks in Kazakhstan to Madagascan hot-dog stands. Not one but two of the presentations made the case that we should be investing in Georgia, and that is what I am going to look at today: how to play the rise of the “Switzerland of the Caucasus”. 

Georgia sits in a strategically enviable spot on the Black Sea, from where it looks west to Europe (Georgia has applied to join the EU), but also east to Asia. It lies on the Silk Road, the trading route to China; there are also rumours it may join the Shanghai Cooperation Organisation (SCO). To be a member of both the EU and SCO would be quite something. 

It has a small, young, proud, ambitious and well-educated population of 3.7 million, 85% of whom are Christian Orthodox and another 11% Muslim. About 35% live in the capital and largest city, Tbilisi. As in so many former Soviet nations, the people want everything we in the West have and more, and they are prepared to work hard to get it. While the older generation mostly speak Russian as a second language, the Westernised, younger folk speak English, French or German. One of the conference’s presenters described Georgia’s education as “mathematically and scientifically oriented”, a legacy of Russian occupation. It is a representative democracy.

Georgia's growth

Georgia’s dark days of post-Soviet Union corruption are mostly behind it, and in 2008 the World Bank dubbed it “the number-one economic reformer in the world” after it went in just one year from being the 112th to the 18th-ranked nation for “ease of doing business”. It now sits sixth in those rankings, with high levels of economic freedom (in 2018 it became only the second country in the world to legalise marijuana) and is one of the fastest-growing economies in Eastern Europe. Taxes, at around 20%, are on the low side. 

One of the ways it ended corruption (as well as sacking the entire police force) was by centralising key databases, such as the land registry and passports, with digital technology. Instead of having to bribe officials, you went straight to the country’s digital headquarters, where fees are flat and transparent. It has embraced new technology and the digital revolution, both in public bodies and in the private sector. 

One reason it has been able to reform and grow so quickly is because it is small. It is also short of natural resources, so the country relies on trade. It is an international transport corridor, especially for commodities. Kazakh uranium, for example, can get to market because of Georgia, which also has key oil and gas pipelines. Its ports, notably Batumi and Poti, are at 100% capacity, and the Chinese are now building a deep-sea port. Historical industries include gold mining – it was to Georgia, or Colchis as it was then known, that Jason and the Argonauts went in search of the Golden Fleece – and wine production. It is still a prolific wine producer.

Georgia stocks to buy

There are no Georgia-focused exchange-traded funds (ETFs), but fortunately, there is another, better option. That is to buy Georgia’s banks. Banks are a very attractive means to gain exposure to a rapidly expanding trading nation. Georgia has two main banks. They are both cheap. They both pay healthy dividends. They are growing. Their IT and financial technology are highly rated. The market has not realised the extent to which they are expanding. And they are both listed in London. 

Tbilisi Business Centre Bank, or TBC Bank (LSE: TBCG) was only founded in 1992. The FTSE 250 member has a market value of £1.7 billion, pays a yield of 7%, is on a price/earnings (p/e) ratio of five, and is buying back its own stock. 

Its headquarters are in Tbilisi and it is the largest banking group in the country, with a range of financial services that include retail, corporate, and investment banking. It has a strong digital presence and caters to 1.6 million customers. As a market leader, it captures a big share of newly registered businesses and has robust loan and deposit portfolios. It’s a well-run company poised for growth. It has recently made acquisitions in neighbouring Uzbekistan, where it is expanding, and yet continues to pay its dividend and buy back stock. 

Bank of Georgia (LSE: BGEO) is a similarly priced FTSE 250 stock, with a market capitalisation of £2 billion, a 5% yield (likely to be higher this year), and a p/e of three. It is also buying back stock and expanding abroad, not into Uzbekistan, but into Armenia. Founded in 1903, it is an older operation, but equally embracing of the new world of IT and fintech. It has wealth management, insurance, retail and corporate banking services, and accounts for around 40% of the banking sector’s total assets. 

Like TBC, it is strategically positioned in a rapidly growing economy, and its numbers are good. It has a solid capital base, a good yield and is consistently profitable. It has a strong market share and diversified revenue streams, including retail and corporate banking, wealth management and insurance services.

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Revolut might still be waiting for its UK banking licence to arrive but the fintech giant nevertheless managed to notch up record profits last year after adding 12 million customers in 2023.

Revolut, which filed for a licence in 2021, made a pre-tax profit of £438 million last year, up from a loss of £25 million in 2022. In its annual report the company also further hinted at plans for a stock market flotation.

Chief executive Nikolay Storonsky said: "We remain committed to our ongoing UK banking licence application in addition to bringing the Revolut app to new markets and customers around the world.

"Even as we reached 45 million global retail customers six months into 2024, Revolut remains poised for exponential growth in 2024 and beyond, continuing to redefine the financial services landscape as we've known it."

Unlike rivals Monzo and Starling, Revolut is still not allowed to offer lending products such as credit cards, personal loans, or mortgages without a banking licence.

UK CEO Francesca Carlesi told Reuters that Revolut’s banking licence application was "progressing well" but that there are "a lot of steps" in the process.

"We are by nature optimistic but you know at the same time, I really don’t think we should put any timeline to this," she said.

Banking licences are typically granted within 12 months of application, guidance from the UK regulator reads. In its latest annual report, Revolut said: “We are continuing to work closely with the [Prudential Regulation Authority] on our UK bank licence application.”

Listing on the horizon?

In its annual report the firm also added that it had “enhanced” its financial controls in ways expected of “listed companies”.

Revolut has signalled its aim to list publicly but the company's interim chief financial officer Victor Stinga declined to comment on any timeline for an IPO.

"Improving financial controls and making sure we bolster our team, being able to release these results within six months, is part of that journey. So we are taking steps in making sure that our control environment trends towards the level you require as a public company," Stinga told Reuters.

Founded in 2015, Revolut is one of a handful of fintech companies to have emerged in Britain over the past decade, offering financial services without having physical branches. Its customer numbers increased by nearly 45% last year.

The annual results, filed ahead of a September deadline, were the first to be published on time in three years.

Standard Chartered, one of the UK’s largest banks and the sponsor of Liverpool FC, has been accused of helping to fund terrorist activities.

Whistleblowers first raised the alarm in 2012, filing a lawsuit in Manhattan that was ultimately overturned. Now, they have filed new documents that claim to show thousands of illegal transactions worth more than $100 billion. 

The transactions were carried out between 2008 and 2013 in breach of sanctions against Iran, the BBC reports.

It adds: “An independent expert has identified $9.6bn of foreign exchange transactions with individuals and companies designated by the US government as funding ‘terror groups’, including Hezbollah, Hamas, al-Qaeda and the Taliban.”

We look at the history of these claims, and what the latest controversy could mean for customers and investors.

Background to this controversy

The history of these claims dates back several years. Two whistleblowers including Julian Knight, a former Standard Chartered executive, first made allegations against the bank in 2012.

We asked Standard Chartered to comment on the latest accusations. It said: “This filing is another attempt to use fabricated claims against the bank, following previous unsuccessful attempts.

“The false allegations underpinning it have been thoroughly discredited by the US authorities who undertook a comprehensive investigation into the claims and said they were ‘meritless’ and did not show any violations of US sanctions.” 

“We are confident the courts will reject these claims, as they have already done repeatedly.”

This is not the first time Standard Chartered has been in the headlines for potential failings in these areas. The bank has previously accepted fines worth more than $1.7 billion after breaching sanctions against Iran, and for poor anti-money laundering (AML) controls. 

Historic fines include a £102 million fine from the FCA in 2019. At the time, this was the second largest penalty the UK regulator had ever imposed for a failure of AML controls. 

Standard Chartered denies carrying out transactions for terrorist organisations. 

How do anti-money laundering rules work?

All banks and financial institutions are required to comply with the laws and regulations of the countries in which they operate. These will vary slightly from country to country, but most have strict rules in place to reduce the risk of money laundering and terrorist financing. 

Let’s take the UK as an example. The FCA has identified certain “high-risk factors”. This includes a list of high-risk countries, where criminal activity is deemed more common. It has also compiled a list of high-risk transactions, including those related to oil, arms, precious metals, and more.

Further precautions should also be taken when dealing with high-risk customers. For example, a political figure is deemed more risky because they could be a target for bribery or corruption. 

The regulator takes these precautions very seriously and fines are doled out to firms that fail to take the necessary steps.

HSBC has been in the news in recent years over “potentially corrupt transactions”. The US Department of Justice fined the banking giant nearly $2 billion in 2012 for “providing banking services to drug cartels and other criminals”.

Banks sometimes introduce new measures in an attempt to stay one step ahead. To cite one recent example, Barclays has now capped in-branch cash deposits at £20,000 for personal banking customers in a bid to fight financial crime. 

What does this mean for customers?

Currently, we are not aware of any implications for customers. It is also worth mentioning that Standard Chartered does not have any direct retail banking clients in the UK. 

Despite being a UK bank, the company carries out most of its retail banking operations overseas. A large portion of its business is conducted in Asia, Africa and the Middle East.

The only retail offering available to UK clients is via the sustainable savings platform Shoal. This was launched by SC Ventures, the innovation arm of Standard Chartered bank, in 2021. 

Shoal allows savers to choose between a series of “savings pots”. These function like fixed-rate savings accounts. 

Funds held in savings pots are protected under the Financial Services Compensation Scheme (FSCS). However, customers should be aware of a couple of points. 

Firstly, their money only enjoys FSCS protection once it is invested in a savings pot. It is not covered when it is just sitting in the Shoal account waiting to be invested.

Secondly, the FSCS protection is not applied to Shoal in its own right. Each time you create a savings pot, your money is sent to Standard Chartered bank to manage. It is through this partnership that your money is protected. 

The FSCS protects savings up to the value of £85,000 with any given institution. If you have more than £85,000 with a bank, it’s advised to split it up and keep it below this level.

What do the accusations against Standard Chartered mean for investors?

So far, the implications of these accusations are unclear. We will have to wait and see how the investigation plays out in the US, where the whistleblowers have filed new evidence.

As we have established, previous anti-money laundering failures and sanctions breaches have resulted in fines for Standard Chartered in the past. 

What we do know is that the FTSE 100 bank’s share price has dipped today in response to the latest headlines. At the time of writing, its stock is down almost 3.5% compared to market open. 

Fines and controversy are rarely good news for a company’s share price – particularly given the importance banking clients place on trust. When Standard Chartered was embroiled in sanctions breaches in 2012, billions were wiped off the bank’s stock market value.

Commenting on the latest headlines and what they mean for investors, Russ Mould, investment director at AJ Bell, said: “In an era when much of the near-term trading is conducted by algorithm-driven funds, [the fall in Standard Charter’s share price today] may not be as informative a signal as it would have once been, but it does emphasise how markets will shy away from the uncertainty this will cause.”

“Patient shareholders may be particularly frustrated that these allegations are surfacing now – even though the bank’s management team dismisses them as baseless – as Standard Chartered has paid out far less on conduct fines and regulatory penalties than the other four FTSE 100 banks.” 

“While Standard Chartered’s tally since 2011 of £1.5 billion is nothing of which the bank will be proud, it pales next to the £73 billion paid out to regulators by HSBC, Barclays, Lloyds and NatWest,” he adds.

Going forward, Mould believes investors will want to see whether the US Federal authorities choose to follow up on the latest allegations, and how long any potential proceedings take. If the authorities do decide to act, he thinks that a deferred prosecution agreement and a fine could be a possible outcome. 

Despite this, he believes shareholders can draw comfort from two key facts. “First, the bank is well capitalised, on the basis of regulatory ratios and requirements. Second, the shares already trade on just 0.7 times book, or net asset, value per share,” he explains. “That discount prices in a lot of bad news already and may provide some downside protection.” 

Nevertheless, Standard Chartered investors will be keeping a close eye on how the situation plays out in the weeks and months to come.

Banking trade body UK Finance has announced the key pledges it wants to see included in general election manifestos.

Arguing that the sector is a “global success story”, its chief executive David Postings said the organisation’s main asks would “help build a better society for all” after the election. It represents the views of 300 firms, including high street banks and financial services providers.

It comes as the major parties have started to draw their key battle lines ahead of the 4 July national poll. The Labour Party has been attempting to build support among the business community, while the Conservative Party has been attempting to win over older voters with its triple lock plus pledge and plans to reintroduce national service.

So, what do the banks want from the 2024 general election? We’ve rounded up their manifesto wish list.

General election winner should improve financial education, banks say

Among its main asks of the next government, UK Finance has outlined the policies it believes are needed to help support people and businesses. It says pledges that will help people manage and grow their money, get onto the housing ladder and get out of financial difficulty are needed.

The trade body said financial education should be a big priority for whoever occupies 10 Downing Street from 5 July. It added that such a move would improve household financial resilience, by giving people the “basic tools and knowledge” to “effectively” manage their money. It follows a report by the Education Select Committee which called for improvements to be made in the provision of financial education in schools.

UK Finance also said it wants to see measures that would boost the returns its members’ customers can gain. It has called for personal savings allowances to be reviewed so that savers can “build up a cushion” against any future cost of living crises. Of course, any growth in deposits would also benefit bank balance sheets.

Other ideas on its wish list include greater encouragement for people to become investors. The trade body wants to see UK households catch up on countries, like the USA and France, when it comes to the proportion of their financial assets that are tied up in equity. It said improvements to the tax regime would help in this regard, whilst also helping to grow the economy.

UK Finance: ‘urgent planning reform needed after the election’

In terms of the measures UK Finance thinks could boost the property market, it said the next government should announce a package of measures “early in the next Parliament” to expand housing supply. Chief among them would be reforms to the planning system, which would “unlock more housebuilding”, it said. The construction of new homes plummeted at the end of 2023, recent figures have shown.

Stamp duty reform is also a priority, the trade body said. It said lowering upfront buying costs would incentivise housing market activity and would free up buyers to improve the energy performance of their home - something it said could also be incentivised by growing homeowner access to financing. The organisation also urged a future government to allow buy-to-let lenders to access the Private Rented Sector Database, which contains information on landlords. Doing so would help to “raise standards” in the lettings sector.

Meanwhile, in terms of helping people to manage financial difficulty, UK Finance said its members should not be the only ones footing the bill for free debt management advice. It wants to see energy and utility companies forced to contribute so that the existing provision can be expanded. The trade body also said it wants greater regulation of the personal debt advice market - an area that’s not currently under the Financial Conduct Authority’s (FCA’s) remit.

Banks call for scam crackdown

Alongside its calls for more support for individuals, UK Finance also urged the next government to bring in tougher action on fraud. In its annual scams report, which was published on 22 May, it found fraudsters stole £2.3m a day from British consumers in 2023.

To stop the yearly £1bn flow of ill-gotten gains, the trade body said online platforms, internet service providers and telecoms firms should be compelled by a new Fraud and Scams Bill to work harder to stop fraud “at source”. These firms should also have to contribute to the cost of fraud reimbursement, and should be brought under the scope of the Economic Crime Levy, which helps to fund anti-fraud schemes. Banks currently foot the bill if their customers fall victim to scams.

UK Finance also said it wants to see Companies House reformed so that the UK is better protected from economic crime. It also wants to see tax incentives to help businesses invest in bolstering their defences against cyber attacks.

In terms of its broader aims for the victor of the next general election, the trade body wants to see Jeremy Hunt’s Edinburgh Reforms expanded through the appointment of a government competitiveness champion. These reforms unwound some of the regulations that were introduced in the wake of the 2008 Financial Crisis.

The champion would review and tackle the “burden” of regulations which “inhibit growth”. Doing so would allow the UK banking sector to compete internationally, and attract more banks to the UK, the trade body claimed.

Prime Minister Rishi Sunak’s decision to call a general election this July has delayed - and likely put paid to - several pieces of legislation.

Among the bills that the Conservative government had hoped to pass - but will now be consigned to the Parliamentary scrap heap - are the Renter’s Reform Bill and Sunak’s plan to create a ‘smoke-free generation’. Other laws, such as the Leasehold Reform Bill, have been pushed through at the last minute.

One government plan that could be facing the chop is the selling-off of the taxpayer’s remaining stake in NatWest. 

It comes amid increasing interest in UK share ownership. So, what’s happening to the policy?

What is the NatWest share sell-off?

At present, the UK government holds a 27% stake in the NatWest group - a collection of brands that includes the Royal Bank of Scotland, Ulster Bank and Coutts.

This significant shareholding is a legacy of the 2008 Financial Crisis, when Gordon Brown’s government opted to prop up several UK banks in a bid to protect consumer deposits. At the peak of this exercise, the public held an 84% stake.

Under the Conservatives, the plan had been to sell the taxpayer’s entire shareholding in NatWest by the 2025/2026 financial year. It’s expected a range of methods will be employed to achieve this, including accelerated bookbuilds and directed buybacks with NatWest, as well as via sales through the ongoing trading plan. Retail investors may also be able to get involved.

What has the government said about the NatWest share sell-off?

During March’s Spring Budget, Jeremy Hunt said a “sale would take place this summer at the earliest, subject to supportive market conditions and achieving value for money for the taxpayer". The accompanying Treasury documents said the “ongoing trading plan is making good progress against [its] objective, having now generated over £5.2 billion of proceeds since launch”.

But the plan could be delayed beyond the summer as a result of the general election announcement. MoneyWeek asked the Treasury whether there would be a delay. A spokesperson said: "A retail offer will not happen during the election period.”

The election will take place on 4 July, with Parliament set to be summoned to meet again on Tuesday 9 July. Early votes will focus on the election, or re-election, of the speaker and the swearing-in of MPs. The state opening of Parliament will not take place until Wednesday 17 July.

It means it could easily be August before a NatWest share sell-off begins, given it’s unlikely to be a top priority for the next government. The plan might not come to fruition until even later in the year if the next Chancellor wants to review it.

Should Labour form a government after the election, the timing of a sell-off may coincide with its first Budget. The party’s shadow Chancellor Rachel Reeves has said this will take place in September.

Neither of the two major parties most likely to form the next government has so far announced what they will do with the NatWest shareholding if they win the election.

What’s been the reaction to the NatWest share sell-off delay?

Market analysts have urged the next party of government to consider reviving the NatWest sell-off.

Dan Coatsworth, investment analyst at AJ Bell, said the delay was a “missed opportunity” to encourage new people into investing. He added: “The government offering its NatWest shares below market price could have encouraged more people to buy shares for the first time.

“While many adults aged 22 or older already put money into the stock market via a workplace pension thanks to the auto-enrolment scheme, a much smaller number of individuals will have bought shares directly. Getting some experience through the purchase of NatWest shares might have been the first step to fostering a longer-term habit of putting money into the market on a regular basis beyond workplace pension contributions.”

Coatsworth also said a sale could raise £6.5bn for the Treasury, if it sold its 26.95% stake at a 10% discount [costing correct as of 28 May]. It means it could be “a straightforward way to raise a significant amount of money” for the public purse.

Head of money and markets at Hargreaves Lansdown, Susannah Streeter, echoed Coatsworth. Looking at previous privatisation schemes, she said they had “super-charged investing habits” amongst novice investors.

She added that any sell-off “should be viewed as an opportunity to spread awareness about the importance of diversification, not putting too many eggs in one basket”.

Research by asset manager abrdn suggests that if, or when, the NatWest share sale happens, there will be plenty of interest.

It surveyed 3,000 adults and found  23% were likely to buy the shares if the mooted NatWest share sale goes ahead – and that’s without a national advertising campaign.

“It’s ironic that just as the UK stock market has started to pick up some momentum, the pause button has been pressed on the NatWest share sale as the UK heads to the polls," says Jason Windsor, interim chief executive at abrdn.

"The good news is that this presents an opportunity for the next government to take the time and space to get this right. That should mean opening up a broader conversation beyond NatWest with a campaign that focuses on the central role investing in the stock market can play in helping to build the savings and investing culture that the country dearly needs.”

According to Nationwide’s latest house price index reading, house prices fell at their fastest pace in almost 14 years in May.

Overall, house prices contracted by -3.4% in May compared to the same period last year, according to the building society.

“However, this largely reflects base effects with prices broadly flat over the month after

taking account of seasonal effects,” said Robert Gardner, chief economist at Nationwide. “Average prices remain 4% below their August 2022 peak.”

In May house prices fell by 0.1% month-on-month, taking the average price of a home to £260,736.

The challenging environment is due to continue

The challenges facing the housing market only look set to continue in the coming months.

Inflation is one of the biggest headwinds facing the market.

While the rate of inflation did slow modestly to 8.7% in March, food prices remain significantly elevated, suggesting the headline CPI figure could remain high for the foreseeable future.

As a result, investors expect the Bank of England (BoE) to continue hiking interest rates, with some analysts suggesting the base rate could peak at 5.5% this year - up from previous projections of 4.5%.

“If maintained, this is likely to exert renewed upward pressure on mortgage rates, which had been trending down after spiking in the wake of the mini-Budget in September last year,” says Gardner.

The average rates on two-year fixed mortgages have risen from 5.26% in early May to 5.38% by the end of the month, while the rates on five-year fixed mortgages have also climbed from 4.97% to 5.05% in the same time period, according to Moneyfacts.

Additionally, lenders have begun to pull deals from the market due to uncertainty around interest rates. According to Moneyfacts, the number of mortgages on the market has fallen from 5,385 deals to 5,012 since the start of last week.

What do rising interest rates mean for mortgages?

“With the markets now betting on more rate hikes ahead, with interest rates potentially peaking at 5.5% - or worse, higher - as the BoE looks to win the battle to tame inflation, this causes problems for the property market,” says Alice Haine, personal finance analyst at Bestinvest.

“The changing interest rate expectations have led to big movements in the bond markets, and as bond yields rise so do swap rates, which lenders use to price home loans.”

Borrowers will have to adjust to higher repayments while also dealing with the higher cost of living and an increase in taxes.

Homeowners on variable or tracker mortgages will suffer the most, as their payments go up in line with BoE hikes. Meanwhile, those on fixed-rate products who are coming to an end will have to remortgage at a much higher rate.

As for first time buyers, “there are a few options”, says Haine. One is to lock in a deal now before rates go up or to delay moving plans.

But in doing so they are at the mercy of record high rents, which will eat into savings at a time when many are already struggling to put enough money together for a deposit.

The City of London is one of the world’s most important financial centres, especially when it comes to insurance. I’m not talking about the general insurance market (covering cars or health, for instance), but the global one for large business-insurance policies and reinsurance. This type of insurance is the oil that keeps the wheels of the global economic machine moving. Without it, trust would dissolve and the economy would be far more volatile.

The Global Cities Report of 2021 notes that London is the only city in the world where every top-20 insurance and reinsurance firm has a base. The insurance sector comprised 24% of the City’s GDP in 2020, according to the London Market Group, which represents insurers and reinsurers. And at the heart of this network is the Lloyd’s of London insurance market.

The oil in the world economy’s motor

All insurance policies are, in the most basic sense, a transfer of risk. For a fixed fee, or premium, I can buy an insurance policy, which will pay out when a certain event occurs. The insurer will try to price the premium correctly based on the assessment of the potential losses and probability of the event playing out. In theory, if the insurance company has done its sums right, the total amount received from customers in premiums every year will be more than it pays out in losses.

A key figure in the industry is the combined ratio. This is the ratio of total underwriting losses, in adition to the costs of running the business, compared with the total amount of premium income received. A combined ratio of more than 100% means the company is paying out more in losses and expenses that it is receiving in premium income, while a ratio below 100% means premium income exceeds these costs. Every insurance company aims to have a ratio of below 100%.

Reinsurance spreads insurance risk further. For example, if a company is selling home insurance in Florida, there’s a high risk it will suffer high losses in its portfolio if there’s a huge hurricane. No matter how accurate a company’s sums are in this case, the sheer scale of the losses could bankrupt it. So, to reduce the risk, it’ll reinsure its portfolio, paying other insurers to take on some of the risk. Reinsurers can then purchase their own reinsurance, a process called retrocession, to spread risk even further.

The global insurance and reinsurance markets work the same way, although the numbers are much, much bigger. This risk transfer is the oil that helps the engine of the global economy work more efficiently. Traders and firms know how much risk they’re exposed to, and if insurers pay out quickly, these customers can carry on business without too much interruption. That’s why it has been said that insurance is the DNA of capitalism.

It could be argued that not having insurance is a bigger risk than anything else, something BP knows all too well. It had opted to self-insure its operations in the Gulf of Mexico to save money, but in 2010 when the oil rig Deepwater Horizon failed, it was on the hook for all of the resulting losses. Today, BP has paid out $70bn in compensation and clean-up costs, selling valuable assets to foot the bill. If it had chosen to buy insurance, the $70bn bill would have been absorbed by several firms across the insurance industry.

Insuring oil rigs and satellites

As the global insurance marketplace has expanded over the past 300 years, Lloyd’s has carved out a niche for itself. This is not a place you go to buy an insurance policy on your iPhone . Its network of capital providers, brokers (who speak to the underwriters on behalf of clients) and underwriters help clients insure specialist risks: it’s a marketplace, not a single entity.

These specialist risks can be anything from oil rigs to satellites. It also insures against cybersecurity attacks, cargo ships sinking and works of art being stolen or damaged. It has a reputation for insuring things others won’t. For example, the first cars were insured through the Lloyd’s market; they were described as a “ship navigating on land.” The market has also become well known as a place where actors and models can insure various body parts, and in one case, Members of the Derbyshire Whiskers Club insured their beards against fire and theft. Lloyd’s is also is the world’s seventh-largest reinsurer. Private investors and wealthy individuals were the first capital providers to the market, although today their share of the market is just 8.3%. But investing in the Lloyd’s insurance market as an individual remains an attractive proposition.

Two options for investors

There are two ways investors can buy exposure to the Lloyd’s market. They can acquire shares in a corporation that has a foothold in the market, such as Hiscox (LSE: HSX), Beazley (LSE: BEZ) or Lancashire Holdings (LSE: LRE). Or they can invest directly as a capital provider.

All three listed firms have a foothold in the Lloyd’s market but also operate independent businesses. Hiscox is a leading provider of small-business insurance and is making inroads into the high-value home-insurance market. Beazley is rapidly becoming one of the world’s leading cybersecurity providers (both in the Lloyd’s market and independently), and Lancashire has been working on its reinsurance offering as well as advising third parties with its Lancashire Capital Management arm. All three are applying lessons learned by working in the Lloyd’s market to drive their expansion.

A good benchmark to use for valuing insurers is book value, with a price of more than twice book being too high. On that basis, Lancashire is the cheapest. It’s trading at a price-to-book value ratio (p/b) of 1.4. Beazley is on 1.8 and Hiscox 2.1.

The primary capital providers to the market until the mid -1990s were individuals known as names. Names entered the market in an unlimited capacity: all of their assets could be at risk if the losses from the market were big enough. After a series of scandals in the early 1990s that wiped out many names, and threatened the future of the market, Lloyd’s was forced to change.

After the crisis, the market introduced new rules and regulations to improve underwriting standards, the quality of capital and protection for investors. The market now has strict capital rules for all participants and requires in-depth risk models to gauge insured risks and highlight areas of weakness. Today, new private investors cannot join as unlimited names. They must join through a Limited Liability Vehicle (LLV), such as a Limited Liability Partnership or a Limited Company. LLVs have significant tax advantages. Both are inheritance tax (IHT)-free as businesses qualifying for Business Property Relief after two years.

In theory, anyone can invest directly into the market, although Lloyd’s used to recommend a minimum of £350,000 and investors are advised to deploy no more than 10% of their assets. Members’ Agents act as the bespoke wealth managers for investors in the market. The largest is Hampden Agencies, which looks after more than half of the private capital in the market today. Alpha Insurance and Argenta Private Capital are two other big names.

Investors have to work with a Members’ Agent to invest in the Lloyd’s market as these agents will ensure investors have adequate capital, produce research on the market and carry out due diligence work such as money laundering checks. An investor also has to select a portfolio of syndicates – these operate like little insurance companies – which they want to back in the market when they join (and can change yearly if they wish); their Members’ Agent will advise on this. Each syndicate operates in a different area of the insurance market specialising in various classes of business and areas of the world, so each has its own risk profile and team of underwriters.

This is a key point: there is a wide dispersion in underwriting performance for all syndicates. That’s just as true with Lloyd’s syndicates as it is with public-market insurance equities. As the famous investor Shelby Davis once noted, “it’s not the winners I’ve owned, it’s the losers I’ve not [owned]”

Hampden is the only Members’ Agent to construct discretionary portfolios, known as MAPAs, for its clients – one of the most straightforward ways to deploy capital into the market. Its experienced analysts pick a selection of syndicates to back with the goal of building a diversified portfolio. These structures are very similar to Open Ended Investment Companies (OEICs) on equity markets. Investors make a commitment to how much they wish to invest, and the Hampden MAPA Manager goes out to deploy that capital. This enables investors to take a more passive approach.

Every insurance company has a portfolio of securities to back up its underwriting activity, and the same applies to private capital vehicles at Lloyd’s. Insurance can be a risky business and every policyholder stakeholder needs to know underwriters can meet their commitments when they fall due. Investors must therefore provide collateral to back up their underwriting and syndicate exposure; this is known as Funds at Lloyd’s (FAL): the equivalent of shareholders’ funds for an insurance company.

The amount of collateral required is based on total exposure through syndicates, and this pot will be used to pay losses if and when they arrive. Every insurer has to have these reserves. Warren Buffett has called this capital the “float,” and he’s become a master of leveraging the capital to the maximum.

The float (both within Lloyd’s and across the rest of the industry) can be invested in the equity or bond markets as long as the company does not breach regulatory capital requirements. Investors in the Lloyd’s market can also use a bank guarantee or letter of credit secured against assets they hold outside of Lloyd’s.

This dual use of assets is one of the reasons investing in Lloyd’s can be so appealing: investors can earn profits from underwriting while the “float” can earn money in the equity market.

Over the 20 years to 2021, Hampden’s discretionary private client MAPAs have returned on average 24.7% on capital from underwriting before fees, expenses and tax. The MSCI World Index (measured in sterling) has returned an annual 9.38% in the same period. So when combined, the dual use of assets could have provided investors with a 34% gross return on capital over the two-decade period before fees, expenses and taxes.

With these sorts of returns, no wonder Warren Buffett became one of the richest people in the world by leveraging an insurance business and investment portfolio at Berkshire Hathaway. And there’s scope for investors to do the same with a Lloyd’s vehicle.

The Lloyd’s market has turned a corner

Despite the insurance market’s strengths, Lloyd’s and the rest of the sector have struggled in recent years. Following a period of low losses on catastrophes in the early 2010s, rates charged by underwriters fell as companies competed for business. Then a series of disasters occurred in 2017, inflicting huge losses, and the trend has continued. According to the Swiss Re Institute, since 2017 insurers and reinsurers have paid out $650 billion (in 2022 prices) for weather-related natural catastrophes claims. Annual losses of $25bn used to be the norm. Now, it’s $100bn. To begin with, reinsurers had to take these losses on the chin. Financial data provider S&P Global recorded an overall combined ratio for the sector of 103.7% in 2017.

However, the market has adjusted. Since 2018 property reinsurance rates in the US have jumped by nearly 100%, according to the Guy Carpenter Rate-On-Line Index. Meanwhile, rates charged by Lloyd’s underwriters have increased by 44.5% since 2018 across all classes of business. The pricing of these types of catastrophe-exposed property insurance can adjust quickly to changes in the loss environment as they are renewed annually.

According to John Francis, the Head of Research at Lloyd’s Members’ Agent Hampden, and the man responsible for the firm’s MAPA arrangements, successful insurance is “ultimately about pricing.” Insurance premiums must reflect the risk accurately. While it’s taken some time for the sector to adjust, “the [Lloyd’s] market has now adjusted to reflect the increased exposure from climate change.”

Swiss Re notes 2022 was the “third-costliest” year on record for the insurance industry with regard to natural disasters. Losses totalled $132bn overall, compared with a ten-year average of $91bn. The P&C industry as a whole saw its combined ratio spike above 100% again off the back of these losses (estimates put the figure between 102% and 106%), but Lloyd’s focus on its core markets is paying off.

It’s “all about managing exposure,” Francis says. Despite the global losses last year, Lloyd’s generated a combined ratio of 91.9% and a portfolio of high-quality syndicates selected by Hampden is forecast to generate a return on capital of 15.4%. This profit

shows that “a diversified portfolio of insurance risks was able to absorb catastrophe losses and still make a profit in 2022.”

Not only is this return attractive compared with the rest of the industry, but it also beats other asset classes. Asset management giant Vanguard notes that a traditional 60/40 global stock/bond portfolio lost 15.7% last year, the worst annual showing since 1937.

This environment of rising insurance and reinsurance rates, along with tightening terms and conditions (known as a hard market) is expected to endure as losses mount worldwide. The Lloyd’s market is uniquely positioned to take advantage by focusing on its core competencies. Private investors in the Lloyd’s market could earn handsome returns from this uncorrelated, tax-efficient and unique investment.

Credit Suisse stock has plunged nearly 58% this year as the bank has fought off scandals and reported large losses. And the selloff in the shares has only accelerated in the past week as rumours about the group’s financial health have started to grow online.

The headwinds hurting Credit Suisse stock

Credit Suisse is in the middle of a crisis, says Ben Martin in The Times. Executives at the “troubled bank” have failed to allay investors’ fears about its “financial health”.

The problem began last week when worries started to circulate “that the lender could be in trouble”. In response, executives “raced to bolster confidence in the loss-making group” through a series of telephone calls. However, the slide in the Credit Suisse share price, which at one stage reached 12% on Monday, and the rise in the cost of insuring its debt against default (measured by credit default swaps) suggest that “those efforts have fallen short”.

The spike in borrowing costs and the fall in Credit Suisse stock is a little extreme given that “there was no obvious bad news to explain the moves”, says Liam Pound on Breakingviews.

What’s more, its managers have a point when they argue that “its liquidity and capital position are strong”.

After all, as of June, Credit Suisse had a “respectable” common equity Tier 1 capital ratio of 13.5%, as well as CHF232bn of liquid assets, around “the sum of its short-term borrowings and quickly-accessible customer deposits”. As a result, “it would take a very large loss or sudden withdrawal of funding to bring the bank to the brink of failure”.

Credit Suisse’s chequered history

Still, it’s not surprising that investors are developing jitters, says Lex in the Financial Times.

Credit Suisse stock definitely “has all the makings of an easy short”. It has had a “chequered history” over the past few years, with losses from the Archegos and Greensill scandals.

There has also been a “revolving door of managers”, with Credit Suisse’s new chief financial officer, Dixit Joshi, starting last Monday. It might be a good idea for CEO Ulrich Körner to “bring forward a promised clean-up”.

Prioritising the strategy announcement is definitely a good idea given that the bank’s third-quarter earnings results, due at the end of this month, are unlikely to be strong enough to reassure investors, says Rochelle Toplensky in The Wall Street Journal. The “broad outlines” – a “scaled-back investment bank and some swingeing cost cuts” – are already known.

However, investors are unsure whether Credit Suisse “will quickly cut the investment bank, which [is likely to] require raising capital at a painfully low valuation”, or instead “try to self-fund the cull, which would therefore need to be slower and narrower”.

Whatever happens, the recent volatility in Credit Suisse stock and credit-default swaps highlights the “deeply unforgiving” mood of the market, says Ben Marlow in The Daily Telegraph.

When a CEO of a major global bank is “drowned out by entirely unfounded speculation on Twitter and internet forums”, some of which came from the account of a YouTube DIY property investor, something has seriously gone wrong. It is clear that in this febrile environment, investors are “looking for any excuse to sell”.

It’s fair to say a lot has changed for Lloyds Bank shares since the mid-1990s. In 1997 the group reported a post-tax return on equity (RoE) of 40%. At its latest half year result, the lender was praised by the City for raising its full-year guidance from 10% to 13% RoE.

The outlook for Lloyds Bank shares has changed

Analysing what has changed and what hasn’t is instructive. Lloyds needed under £6bn of shareholders’ equity to deliver post-tax profit of £2.35bn in 1997.

In those days, when the Spice Girls were topping the charts and Pete Sampras was winning Wimbledon, shareholders’ equity was just under 4% of total assets of £158bn.

Shareholders’ equity stands at £50bn today, and the bank’s total assets have ballooned to £886bn. But profits have not kept pace with the bank’s balance sheet growth. If they had, then Lloyds would be reporting the highest profits of any company in the FTSE 100 index.

Dividend growth has also been a disappointment. The total payout of £0.9bn on Lloyds Bank shares in 2021 was just the same as the distribution in 1997.

The good news is there are some favourable tailwinds blowing across the banking sector.

Inflation and rising interest rates

Lloyds doesn’t have a problem with funding – it has £478bn of deposits, up £70bn compared to a couple of years ago.

As restaurants were closed and travel was difficult over the pandemic, consumers had few options to spend, and savings ended up accumulating in bank accounts.

As the bank is offering loyal savings customers just 0.2% interest on savings, annualised interest expense for the bank is just £500m on those almost half trillion pounds of customer deposits.

The bank can take these deposits and lend the money overnight to the Bank of England earning 1.75% with no risk or buy UK Government bonds, currently yielding above 3%. In simple terms, Lloyds is not passing on the benefit of interest rate rises to savers, and if this continues will enjoy windfall profits.

Windfall profits should be a net positive for Lloyds Bank shares, although the past two decades have shown that bad behaviour by banks and poor PR has been bad news for shareholder returns, while senior management has continued to do very nicely from bonuses.

Will falling house prices dent profits?

The biggest risk to the company’s outlook is the prospect of an economic slowdown and falling house prices, which will lead to rising bad debt impairments.

The cheap mortgage deals and stamp duty holidays which re-ignited the UK housing market during the pandemic have come to an end. Rates on two-year fixed mortgage deals have trebled in the space of 12 months.

This tightening of credit conditions is already having an effect on the market. The Bank of England’s most recent figures show mortgage approvals, a lead indicator for the housing market, down 14% year on year.

Lloyds mortgage book stands at £310bn and has an average loan to value (LTV) ratio of 40%. Unlike the run-up to the financial crisis, Lloyds has just 3% of mortgage balances on an LTV of greater than 80% as regulators have discouraged high LTV lending.

In other words, house prices could fall 20%, and just 3% of the bank’s mortgage borrowers would find themselves in negative equity. That means a fall in house prices similar to that seen in the 2008 crisis is not, in itself, enough to cause the bank a problem.

The unknowable risk to Lloyds Bank shares

Instead, the unknowable risk is unemployment. The Bank of England is forecasting five consecutive quarters of recession, with unemployment, a lagging indicator, starting to rise halfway through next year.

For context, in the three years following the financial crisis Lloyds took an impairment charge of £8.9bn in the retail bank alone, of which £4.2bn was in 2009. The vast majority of those impairments were from unsecured bad debts, such as credit cards, rather than the mortgage book.

Industry data shows credit card borrowing is increasing by 13% annually, the highest annual rate since October 2005 (+13.7%) could be an early warning sign of problems to come.

In response, Lloyds says that credit borrowing is not being driven by the cost of living crisis.

Instead, wealthier households are spending on non-essentials like travel, which is up 300% year on year and has now recovered to pre-Covid levels. Analyst consensus forecasts for the bank show current expectations are for losses well below those experienced following the financial crisis: £1.2bn impairment for group bad debts next year, rising to £1.4bn in the 2024 financial year.

If those forecasts turn out to be right, then the bank is trading on a price/earnings ratio of below seven times 2023 and 2024 earnings. The forecast dividend yield is close to 6%.

Enjoying a benefit from rising interest rates means that Lloyds Bank shares could outperform the wider market, as most stocks are harmed by rising interest rate expectations.

As it retreated from markets in the Americas and Europe, HSBC (LSE: HSBA) formally dropped its “world’s local bank” tagline in 2016.

Despite its global ambitions, Hong Kong has always been HSBC’s main market, with around 90% of group profits historically coming from its Asian business. And in recent years management has doubled down on China, shifting $100bn of capital to the region as the bank has exited other regions.

HSBC’s focus on China is producing mixed results

The results of the group’s new strategy have been slow to materialise. Revenues have stagnated over the past six years, and profits have been unpredictable. As an investment, the stock has been dead money since 2017 (even after adding in dividends). It has lagged the market by half over the past decade.

Most of these challenges are a direct result of the firm’s new strategy. Sales have come under pressure as it exits markets, while the costs of the restructuring have eaten into profitability. That’s without considering the twin headwinds of economic uncertainty and ultra-low interest rates.

With interest rates on the up, HSBC’s outlook is beginning to improve. What’s more, even though economic certainty remains, it is in a far better position today to cope with volatility and instability than it was in 2018-2019.

Notably, the company has made significant progress cutting costs and has redoubled its efforts to reduce spending in the second half 2020. It is now beginning to reap the rewards. As other organisations struggle to offset rising wage pressure with higher prices, HSBC is expecting costs to remain flat this year as it cuts a further $2bn from operating spending.

In the first quarter, reported operating expenses declined by 3% as “continued growth in technology investment” offset inflationary pressures.

Lending growth continues to boost profits

Keeping a lid on costs will help HSBC outperform in a tough market. It has already increased its provision for bad loans in the year. It reported a profit before tax of $4.2bn for the first quarter, down $1.6bn due to “a net charge for expected credit losses and other credit impairment charges” as well as the costs of exiting the Russian market.

HSBC also reported a 4% decline in reported revenue to $12.5bn. Less capital market activity hit trading revenues at its investment bank, offsetting lending growth.

Still, lending is a bright spot for the firm. Consumer lending balances expanded to a net $9bn and net interest income increased in all global businesses. The bank’s net interest margin – the difference between the rate of interest the group pays to depositors and charges to borrowers – increased by 0.05% to 1.26% in the first quarter as overall lending income rose by 7.7% year-on-year.

The loan book is where HSBC has the potential to generate real growth over the next couple of years. With a common equity tier 1 ('CET1') capital ratio of 14.1% at the end of the first quarter, and an estimated $700bn in surplus deposits, it has the capital to grow lending volumes.

Investment banking can be a very profitable business, but it is also volatile, requires a lot of balance sheet capital and is very relationship driven. Well-connected (and well paid) bankers are needed to keep clients sweet.

The investment bank is an important part of HSBC’s business strategy, but lending to consumers and businesses is far more stable and predictable. These divisions also require less balance sheet capital and lending decisions can be executed (and serviced) by technology. The fees on a 25-year mortgage might pale in comparison to a $25bn merger, but the lender can process thousands of these lending decisions every hour using technology to reduce costs. This volume and the predictable interest income makes up for the smaller up-front fee.

HSBC is expecting a mid-single-digit percentage increase in overall lending growth this year, due to a combination of higher interest rates and more lending. Management also believes fees from its wealth management business will also recover when pandemic restrictions are lifted in Hong Kong.

If the bank can boost earnings, HSBC shares could be cheap

After half-a-decade of change and development, HSBC has a lot of scope to grow over the next few years. That said, economic uncertainty is already having an effect on profits, and with the outlook for the global economy only deteriorating, I would not rule out further negative developments.

Still, with the shares trading at a price/book (p/b) value of 0.7 and forward price/earnings (p/e) multiple of 9.9, HSBC looks cheap if it can continue to grow over the next few years. Its dividend yield sweetens the appeal. Analyst projections also have the stock yielding 4.3% this year, although management is warning that further share buybacks are unlikely as uncertainty persists.

Considering its valuation, the company could be a cheap way for investors to play the growth of the Chinese economy and rising interest rates. However, as uncertainty builds, some investors might prefer to seek protection elsewhere.

It’s hard to believe now, but UK banks’ share prices had a strong start to the year, up between 15% and 25% until mid-February. They reported results for the financial year ending December 2021 at the end of last month, with no obvious problems. We saw profits rebound and outlook statements suggest improving revenue and further capital returns to shareholders in the form of dividends and share buybacks. Then Russia invaded Ukraine and NatWest’s, HSBC’s and Lloyds’ share prices fell by more than 20% from their 2022 highs. Barclays has been hit even harder, down 30%. They have since rallied somewhat, but still remain down by between 12% (HSBC) and 22% (Barclays).

Direct exposure to Russia plays little part in this. UK banks have $3bn exposure to the Russian financial system, according to the Bank of International Settlements (BIS). While $3bn may sound like a lot of money, Austria (mainly Raiffeisen) has six times more exposure at $18bn. French (mainly Societe Generale) and Italian banks (Unicredit and Intesa Sanpaolo) have eight times more exposure at $25bn each. Societe Generale has said that it would be able to withstand the extreme scenario of having its Russian bank confiscated by the authorities, but so far banks have admitted losses that are in the tens of millions, not tens of billions.

Following the 2008 financial crisis, lenders are in much better shape to absorb losses, mainly because regulators demanded that they rebuild their capital ratios and fund with more equity. Excluding NatWest – which has sold businesses and shrunk total assets by a trillion dollars – the sector has now increased tangible equity funding by around $90bn in the last ten years. In total, UK banks have $420bn of equity to absorb losses. So while $3bn UK bank direct exposure to Russia might sound like a lot of money, it really isn’t compared with the equity on their balance sheets, and is much less than that of European competitors.

Reassuring results

Results for the 2021 financial year were reassuring. Bank profits have been in long-term decline, but recovered in 2021. This was driven by lower bad debts compared with 2020, because banks took large provisions at the start of the pandemic and found that bad debts weren’t as high as the worst-case scenario. Hence statutory profit before tax doubled at HSBC and trebled at Barclays. The two banks the government rescued in 2008 fared even better, with Lloyds increasing profit before tax sixfold and NatWest recovering from a loss in 2020 to report a £4bn profit.

All UK banks have profitability (as measured by return on tangible equity – ROTE) targets of 10% or above and the outlook statements (which were written before the Russian invasion) sounded more confident that these can be achieved. For instance, HSBC said that it was likely to achieve at least 10% ROTE in the 2023 financial year, a year earlier than it had previously expected. Barclays and Lloyds already exceed their targets, reporting 13.4% and 13.8% ROTE respectively. This was helped by each bank’s revenue performance, but also a £0.7bn impairment release for Barclays and a £1.7bn release for Lloyds.

NatWest announced a £750m buyback; Barclays £1bn and Lloyds £2bn. The Asian-focused banks (HSBC and Standard Chartered), which are reporting lower returns and were trading on lower price to tangible book multiples, announced $750m and $1bn buybacks respectively. However, those buyback announcements have done little to support share prices. Since the obvious exposures to Russia’s economy are manageable, it’s the secondary and tertiary effects that share prices are responding to, and that’s what we should be thinking about as well.

Central banks have been slow to tighten

Merryn interviewed Andy Haldane, previously the Bank of England’s chief economist, for the MoneyWeek podcast in July last year. Haldane worried that other central bankers were too relaxed about the risk of inflation and that its effects might not be transitory. In June last year he was the only member of the Bank’s monetary policy committee (MPC) to vote to raise interest rates. He suggested that inflation could exceed the Bank’s 2% target for longer than most people expected, which would result in central bankers’ credibility being questioned.

Although central banks were slow off the mark in tightening policy, by the start of this year the strength of the post-pandemic economic recovery meant that most analysts were expecting to see steadily rising interest rates. You may be wondering: if interest rate rises have been expected, why the panic now?

Ultra-low interest rates are no good for banks, because banks make money from lending out their deposit funding. In normal times, customers’ deposits (which are liabilities on banks’ balance sheets) represent a cheap and stable source of funding. However, when interest rates are below 1%, banks don’t derive any benefit from this deposit funding, because there’s so much other liquidity freely available. As interest rates rise, banks will be slow to pass on the benefit to savings customers. Instead, net interest margins will widen (which is better for shareholders than it is for customers). As long as central banks are responding to a strong economy, rising interest rates are good news.

That was the bull case. But Russia’s invasion of Ukraine and the oil price rising to over $120 per barrel has changed the outlook.

The threat of stagflation

HSBC warned in its annual report that “further increases in energy prices – for instance, as a result of escalation in the Russia-Ukraine crisis – could keep inflation high and force central banks to tighten monetary policies faster than currently envisaged”. During the global financial crisis of 2008-2009, oil peaked at almost $150 per barrel – trebling from the $50 per barrel it traded at in January 2007. At the time a wiser, older broker told me: “Oil has never trebled in value and not caused a recession”. It wasn’t different that time and it probably won’t be different this time.

The problem is that we may see consumers’ disposable incomes being squeezed by higher commodity prices, rising inflation and rising unemployment all at the same time. That is what happened in the 1970s and it’s known as “stagflation” (stagnation + inflation). History shows that while quantitative easing might have helped stimulate growth from 2008 onwards, central banks can’t print their way out of a commodity shock. Longer term, rising inflation combined with rising unemployment is unambiguously negative for banks’ share prices. Any benefit from higher interest rates would be wiped out by bad debts.

These are the risks that share prices are reflecting. And if we see stagflation, investors should avoid the sector altogether. But if these fears are overstated, there could be some value in banks at this point.

The case for NatWest – Britain’s worst bank

A common-sense investment strategy is to pick a sector with favourable long-term prospects and buy a company from that sector that has favourable economics. An example might be Halma or Spirax Sarco in the engineering sector.

When it comes to UK banks, common sense works less well. The “quality” bank with the best long-term record is HSBC, whose share price has halved in value in the last 20 years. It’s not much good to point out that in relative terms HSBC has done better than the competition: Lloyds and NatWest were part-nationalised and shareholders diluted by the government in 2008. Barclays has fared little better, with the shares down by 70% compared with 20 years ago. In short, banks have not been “buy and hold” investments. With that in mind, I would suggest a different, counter-intuitive approach: wait until the tide is on the turn and then buy the lowest-quality bank, which is NatWest.

Expectations are low: NatWest lost money for nine consecutive years following the financial crisis. However, NatWest has essentially been three businesses i) a non-core shrinking “bad bank”; ii) good businesses that it was forced to sell as a result of receiving state aid (eg, Direct Line Insurance); and iii) a profitable core franchise. The years since the financial crisis have been dominated by the first two factors, but by their nature they have declined in importance and the core franchise should become more important.

NatWest’s annual report shows the bank should benefit by almost £1bn from a one percentage-point parallel shift in the sterling yield curve (that means short-term rates rise as the Bank of England raises the base rate, but the ten-year bond yield – which central banks don’t control – goes up by the same amount). That’s an automatic benefit equal to 25% of last year’s profit before tax of £4bn. As long as the yield curve remains upward sloping – meaning short-term rates (eg, 2%) remain lower than longer-term bond yields (eg, 4%) – some of that benefit is sustainable in future years.

Aside from the macro-economic background, there are still company-specific concerns. For instance, last year NatWest paid £466m of “conduct costs” for the financial year 2021, including £265m for money laundering for a Bradford jeweller that deposited £260m in cash, some in bin bags with a “musty smell”. Many of these problems were the result of cultural failings – and as the bank shrinks, it should become easier to avoid these hangovers from the past. Note also that the UK government still owns 52% (down from 97% in 2008), but not all of these shares are being placed on the market. Instead, NatWest is buying back from the government at the market price.

NatWest is trading on 0.5 times revenue and 0.6 times tangible book value. The forecast price/earnings ratio is less than six times forecast 2023 earnings, according to SharePad. That suggests investors believe it will deliver returns well below management’s target of 10% ROTE. But having shrunk its balance sheet by over £700bn in the last decade, the bank has been de-risked. The share price currently looks to be anticipating a very difficult stagflationary environment. The Ukraine war and sanctions may drive that scenario – but if we see commodity prices fall, that would be the signal the tide has turned, and would be the time to buy.

It all started with the Big Bang in 1986. That was Margaret Thatcher’s attempt to shake up the cosy relationships in the City of London and build a globally competitive financial services industry of which the country could be proud. The old separation between brokers and jobbers (market makers), and between retail and investment banking, were dismantled and cleared away – without much consideration of whether there were sound reasons for these divisions to exist, like Chesterton’s Fences.

Retail banks such as Lloyds, Barclays and Midland were allowed, if not encouraged, to own stockbroking firms. The likes of de Zoete Wedd, Hill Samuel and Samuel Montagu were bought by UK retail banks. Other brokers such as Phillips & Drew, Warburg’s and Smith New Court were bought by large investment banks from overseas. UK banks expanded into new territories and built empires where the sun never set. Banks attracted a new breed of rocket scientists and physicists to help them price complex derivatives. A new model emerged: “universal banking”, implying a bank could do everything under one roof. London became a centre of global financial competition.

The Big Bang was good for London as a financial centre, but there were two questions no one thought to ask: was it good for customers, and was it good for shareholders? The answer to both questions is an uncontroversial “no”.

Few benefits for customers

Barclays’ fixed-income division may have risen up the corporate-bond underwriting league tables, but it is hard to see how this brought any benefits to a Barclays current-account customer, for example. Even for retail banking products, having a current-account relationship with one bank doesn’t mean a better mortgage deal or cheaper home insurance. It is almost always true that customers do better to look at the best-buy tables than trust their bank to cross-sell to them. This is especially true of mortgages, where high house prices mean a large mortgage over 30 years is very sensitive to the interest rate offered, and hence customers would be mad not to go to a mortgage broker to find the best deals on offer. The same logic applies to credit-card customers, driven by eye-catching balance transfer rates. So using current accounts to cross-sell additional banking products has proved more difficult than universal bank management would like to admit.

It is even harder to see how a customer of what was once Midland and is now part of HSBC benefits from the parent company’s high market share in Hong Kong, let alone the ill-advised expansion into Mexico, Brazil, Argentina, or risky US subprime mortgages. It is patently ridiculous to claim that HBOS, the UK’s biggest mortgage lender, was somehow helping local borrowers in Halifax by also lending money to fund the buy-out of M Resort Spa Casino in Las Vegas in the run-up to the global financial crisis in 2007-2009. Indeed, HBOS’s management were securitising their high-quality UK mortgages and selling them in financial markets, and replacing these assets with collateralised debt obligations (CDOs) sold to them by US investment banks, which contained packaged up lower-quality US subprime mortgages.

No economies of scale

Aside from customers, the universal banking model has not been kind to shareholders either. The UK banks have underperformed the FTSE All Share index since 2002. Yes, even before the financial crisis banks were unloved by fund managers, who worried about overleveraged balance sheets, and how sustainable returns on equity would turn out to be. As it happened, the fund managers were right to be wary.

As the pull of size and consolidation worked on UK banks like gravity, this was justified in the name of efficiency. The trouble is that there is very little evidence that big banks are more efficient. Instead, they became in danger of collapsing under their own weight, like financial black holes. The cost/income ratios for large UK banks such as Barclays, HSBC, Lloyds and NatWest were all above the 60% level in the 2020 financial year – not much improvement from cost/income ratios seen ten, 20 or even 30 years ago. The smaller UK mortgage banks such as Northern Rock (before it failed) operated a more efficient model, with a cost/income ratio close to 30%.

My own experience of banking efficiency as an employee supports this. Over the years I have worked at both large banks (Credit Suisse, Societe Generale) and smaller brokers (none of which have survived to the present day.) Arriving at any small broker on my first day of work, my IT systems were set up, my Financial Services Authority registration had been transferred over and my new colleagues were pleased to see me. At large banks the first day tended to be shambolic. Most conversations with HR and IT started with the sentence: “Oh, hello! We didn’t know you were starting today”.

That’s because bringing all the banking activities under one roof created more complexity than any efficiency savings. Banks still needed to spend lots of money on technology systems. And any savings from streamlining the back office were lost, because they needed to employ an army of legal and compliance staff to manage conflicts of interest, for instance building “Chinese walls” to keep employees with inside information separate from market-facing roles and prevent the bank being fined by the regulator. The huge increases in computing processing power and decline in the cost of computer hardware hasn’t benefited shareholders in banks at all. By December 2014, Antony Jenkins, the then-chief executive of Barclays, was admitting that the universal banking business model was dead. Diversifing by business, customer and geography hadn’t worked.

Banks have many challenges

In recent years, low interest rates have made life even harder for banks. Most of the time, banks make a margin on their retail deposit funding, because their average interest costs are below central bank rates. But when base rates drop below 1%, margins shrink because the banks can’t charge customers enough for looking after their savings (notwithstanding the efforts of some European banks to levy negative rates on retail deposits). As interest rates rise, analysts expect banks to increase revenue. Still, while margins are set to improve, technology spending is likely to rise even faster and bad debts are hard to predict.

Setting aside the barrage of regulatory fines, the other reason that banks have struggled to generate the return on equity (ROE) that the market wants (10%) is that the regulator has demanded that they fund their balance sheets with less debt and more equity. Larger banks that are judged “systemically important” have to fund with even more equity, because of the serious consequences of failure. In very simple terms, that even bankers can understand, if the “R” of ROE stays the same but the denominator “E” increases, then it is a mathematical inevitability that ROE will fall.

A further problem is that banks tend to reward their loyal customers with worse deals than the new customers they are trying to tempt away from other banks. In the short term, this strategy works. Customers have better things to do than check they’re still getting a good deal every couple of months. But over time, the strategy is bad news for shareholders. It’s terrible for banks’ brands to use inertia from loyal customers to generate high returns. Thus the last few years have seen disruptive new entrants, such as Atom, Monzo, Starling and Funding Circle.

In theory, these financial technology (fintech) firms can offer more competitive services because they don’t have legacy IT system costs or a branch network. That said, given that the disrupters tend to be loss-making, it could just be that their services are being funded by deep-pocketed venture capitalists.

Last year the UK saw $11bn of investment into fintech. There were 713 deals, with Revolut, Monzo, and Starling in the top five amounts raised. Zopa, the peer-to-peer lender founded almost 20 years ago, still managed to raise $220m from SoftBank’s Vision Fund 2. The UK fintech sector seems particularly good at attracting capital, because that $11bn is more than double the next largest in Europe: Germany ($4.4bn), followed by France ($2.3bn) and Sweden ($1.7bn). Overall, $24.3bn was invested across the continent in 2021, with the UK representing nearly half (45%).

Most disrupters aren’t disrupting

That sounds impressive, yet the pandemic has not been the boon for fintech that it has been for tech firms, as Marc Rubinstein points on Net Interest, his financial sector blog. Monzo’s fund raise in May 2020 was at a 40% discount to its previous funding round. German digital bank N26, funded by Peter Thiel, pulled out of the UK after finding the competition too strong.

Meanwhile, branch-based challenger bank Metro Bank has fallen 95% since its initial public offering (IPO), while peer-to-peer lender Funding Circle is down 75% since its IPO at the end of 2018. These have not been anyone’s idea of a successful investment.The problem is that UK banks’ core business of taking customer deposits and lending out money is highly competitive. Thus the fintech winners are not the ones trying to re-invent universal banks. Revolut and Wise (formerly TransferWise) show that fintech isn’t just about technology, it’s also about finding the areas of greatest risk-adjusted return. They have focused on cross-border payments, attacking the huge difference between the currency rates available to large corporate clients in wholesale markets and the price that retail banking customers pay.

Ten years ago there was a complaint to the Office of Fair Trading by consumer groups because banks were charging 3% on foreign currency transactions. Some debit cards also added a further fee of £1.50 per transaction, while using a bank card to withdraw cash abroad could cost up to £4.50 a time. At the time a spokesman for the British Bankers’ Association (BBA) blamed the high fees on foreign payment systems, saying “transaction costs abroad are driven by the costs of overseas payment systems, often in countries where free banking does not exist”.

Of course, this was nonsense. And hence both Revolut and Wise were founded by eastern Europeans who were appalled at the price gouging from banks when they wanted to send money home.

Wise and Revolut: the two winners

Wise was originally a way to send money to bank accounts overseas (see below). It unbundled a specific financial product and offered better value than the competition, with no cross-subsidisation.

Revolut began as a pre-paid card and an app for spending money abroad. It planned to levy a small fee every time a customer used the card, but realised that there wasn’t enough money in this to support the cost and started charging subscriptions. It is remarkable that an app can charge customers up to £13 a month, while UK retail banks with higher-cost branches and legacy systems struggle to convince customers to pay anything. Rather than lower costs, Revolut is able to make money by charging customers to access services they value, such as crypto trading, which has done well over the pandemic. That said, Revolut’s subscriptions made it £222m of revenue in 2020, but direct costs and administration expenses meant that the business made a loss of £207m the same year.

Wise and Revolut attracted millions of customers, despite not having a banking licence. They had an e-money payments institution licence, which means that they weren’t able to lend out money to borrowers and take credit risk. Instead, they have to keep customer funds in cash or other low-risk alternatives. (Revolut was granted an EU banking licence last year.)

So the great irony of fintech is that technology has not meant bigger, more efficient banks. Nor has it allowed new entrants using technology to disrupt saving and lending. The real success story is built on the fact that wholesale customers who deal in large size receive a better price than individuals. That’s true in any industry and financial services is no different. That was the original reason for brokers (who bought and sold on behalf of retail clients) and jobbers (who made a market and dealt wholesale). Wise and Revolut have used technology to reduce the size of the retail versus wholesale price difference. That outcome is light years away from anything foreseen at Big Bang.

Is Wise worth 90 times earnings?

Wise (LSE: WISE), which has a March year end, put out a third-quarter trading update in mid-January. It’s enjoying strong growth, transferring over £20bn in the three months to December, up by 38% from a year ago. So far this strong transaction growth has meant reducing costs, the benefit of which it shares with customers by driving down fees, while generating cash for reinvestment.

The firm says that over the last year it dropped prices across 50 currencies and fees are now 0.60% of transaction value on average, nine basis points lower than a year ago. It was profitable in the first half of the year, to September 2021, making £19m, and analysts are forecasting profits to reach £150m in the 2024 financial year, according to data from SharePad.

Analysts covering Wise are forecasting around 24% revenue growth in 2023 and 2024, and the total addressable market for cross-border transactions is huge. There were around £2trn of global cross-border payments made by individual consumers in 2020. Around two-thirds of that is done by banks – Wise estimates that it has a market share of around 2.5%. That £2trn pool is also growing.

Like many fast-growing tech stocks, the shares look expensive. The forecast price/earnings (p/e) ratio is 90 and price/sales (p/s) ratio is 15, according to SharePad.

This approach to growing fast and sharing efficiencies with users is similar to Amazon’s. Even after 25 years of growth, the “Everything Store” now has revenue of half a trillion dollars, but shows no signs of going ex-growth. It trades on a forecast p/e of 70. In his 2005 letter to shareholders, Jeff Bezos described Amazon’s strategy in this way: “Our judgment is that relentlessly returning efficiency improvements and scale economies to customers in the form of lower prices creates a virtuous cycle that leads over the long-term to a much larger dollar amount of free cash flow, and thereby to a much more valuable Amazon”.

Wise, like Amazon, intends to expand its product offering. It recently launched a service called “Assets” for UK customers. They can now transfer balances to an index fund, while still being able to spend or transfer money overseas as though the balance were still held in cash.

There are risks to Wise. One concern is the co-founder, Taavet Hinrikus, selling 11 million shares last year, and entering a loan agreement with Goldman Sachs where up to 49.6 million shares would be pledged as security. There’s also a dual share structure common to many tech stocks. The founders hold B shares that have nine times more votes than the A shares. That lets them keep control even if they decide to cash out their A shares.

I think the bull case is relatively easy to make, but the high valuation multiples mean that if the company disappoints, then it’s likely to be punished severely. For every Amazon-style investment, there are plenty of Groupons and Pelotons that don’t receive much attention – once hyped stocks that failed to deliver.

In the quiet week leading up to Christmas, the Irish government said it plans to start selling off part of its 71% share of Allied Irish Banks (AIB). Over the course of the next month, slightly over 3% of the equity will be placed on the market, and, if it goes well, we can expect to see the rest of the shares steadily sold off over the next few years. This raises a question: why don’t the British banks make a move and buy it up?

The go-go years

AIB has had a mixed history, to put it politely. In the wake of the 2008 crash and the eurozone crisis that followed it, and with fresh capital impossible to raise, the bank was bailed out by the Irish government for an eye-watering €21bn. Leading up to that, like many of the Irish banks in the go-go years after the country joined the single currency, AIB had expanded and lent wildly. Even a decade later, there is probably not much hope of ever getting the money the state invested back. The share price would have to more than triple for the Irish taxpayer to make a return on the rescue. Still, all that is history. It still looks like a tempting buy for British banks.

Sure, it is easy to make the case for caution. Irish banking, even more than most comparable markets, has a history of wild boom and bust cycles. No one wants to buy in just before the next crash. The British retail banks have struggled to expand in other countries, often spending a fortune, and then being forced to retreat. And the finance industry has plenty of challenges to deal with, from responding to the rise of app-based competitors to coping with rising interest rates to closing down obsolete branch networks, without distracting themselves with foreign acquisitions. On top of all that, the issues over Northern Ireland mean relations between the governments in London and Dublin are very strained; Irish ministers would probably not be very pleased by a British takeover of one of the country’s largest financial institutions.

Still, there is a strong case in favour as well. Ireland is still a very attractive banking market. It has long since recovered from the financial crash and remains one of the fastest-growing of the developed economies. Indeed, it was the fastest growing economy in the EU last year, and its overall output is now significantly above the pre-pandemic level. Its low corporate tax rate still makes it a key hub for global multinationals (it may have to raise that under plans to create a global minimum corporate tax rate, but the country still has plenty of momentum to carry it forward). Its GDP per capita is one of the highest in the world and wages are high. With an average age of 38, the population is relatively young (it is above 40 in the UK). Its housing market has bounced back from the crash, and is robust and stable. And, of course, it is inside the European Union’s single market, making it a natural base for providing financial services right across the continent.

Seize the day

It is hard to see why none of the British banks would be tempted by that. It’s not as if they don’t need fresh sources of growth. Lloyds is expanding into the housing market, which hardly seems a safer bet. HSBC and Barclays are building up their capital markets units. NatWest already owns Ulster Bank, and although it said it was withdrawing from the market south of the border last year, and still has to complete its own privatisation, it has plenty of experience of the market.

AIB or Bank of Ireland would make a perfect acquisition for one of the UK’s big four retail banks. With market values of around £5bn, they are not hugely expensive, and are hardly going to be a strain on anyone’s balance sheet. If they don’t want to expand into the Irish market, then it is hard to see what country they would be willing to take on. A cash offer would save the Irish government a lot of trouble, and at a 20% to 30% premium would make it more money than selling off the shares in dribs and drabs. The only real question is whether one of the British banks will be brave enough to seize an opportunity that might not come again.

Last year HSBC took “billions of dollars” in loan losses, say Stephen Morris and Tabby Kinder in the Financial Times. Now it has announced an “almost fivefold rise in second-quarter earnings as the global economic outlook brightened”. Pre-tax profits “surged” from $1.1bn last year to $5.1bn in 2021, while the group “cancelled a further $300m of credit provisions”.

HSBC’s decision to reinstate its dividend is “another good sign” for shareholders, says Jennifer Hughes on Breakingviews. However, the fact that it is handing back “a mere seven cents a share for now”, suggests that HSBC’s management think that things are “only slowly moving in the right direction”. The payout, worth far less than half the group’s earnings, is pretty “meh” when set against UK rivals Barclays and NatWest. And while HSBC is saying that it will now “consider” buybacks, shareholders “shouldn’t hold their breath”. Don’t expect any major share-price rises either, says Emma Powell in The Times. Part of the problemis HSBC’s focus on Asia. In theory, it implies “arguably the greatest growth potential of any of the big five banks listed on the LSE”, since the region benefits from “an ascendant middle class and rising demand for wealth-management services”.

But the share price remains depressed by “geopolitical concerns”, especially the “fragile relations” between the West and China and Hong Kong, which account for half of its profits. HSBC is still feeling “intense heat” over its support of the national-security law that China imposed on Hong Kong.

Even hermits have heard of the collapses of Australia’s Greensill Capital, named after its founder Lex Greensill; America’s Archegos Capital (named from the Greek word for “leader” by its founder, Bill Hwang); and Germany’s Wirecard AG – a tiny casualty in the 2000 dotcom crash, then recapitalised in a reverse takeover by its CEO, Markus Braun.

Each of these men was a middle-management unknown claiming to have reinvented arcane areas of finance using new technology – which no-one questioned – to create eye-watering profits. Each was a consummate networker whose smooth sales patter attracted influential names from politics and business, creating a snowball effect. And each was leveraged to the hilt.

What intrigues me most is why some of the largest and theoretically most savvy banks in the world lined up to shovel ever more money into gaping black holes. This incompetence will do little to change the perception following the 2008 crash that banks and finance companies are unreformed gamblers. Yet despite these losses and rapid change throughout the sector, the investment case for banks is compelling.

Still too big to fail

After the 2008 meltdown in the global financial system the mantra was that no bank should ever again be “too big to fail”. In reality the big boys are still gobbling up the weak. A maximum of five banks dominate in every country. America is about to witness a frenzy of banking takeovers. Small challenger banks, sponsored by governments, were meant to shake up the market by taking on the established players. The UK is a leader in this regard, as well as in “fintech” – tech-driven financial services.

But these developments haven’t dislodged the dominant banks. This is a sector predisposed towards producing big beasts. In finance, size brings advantages, spreading costs and providing economies of scale in technology and compliance. The largest challenger is Virgin Money, an agglomeration of unloved banks whose assets are worth about 7% of those held by the UK’s No.2, Barclays. The assets of all challengers and fintechs amount to less than the Nationwide Building Society’s; it is the seventh-largest traditional bank.

Attracting customers with special offers is easy; making them profitable is not. Nor are the challengers cleaner than the behemoths. Metro Bank in 2018 was found to have mis-classified loans, thus breaching capital adequacy rules while the then-chairman had paid his wife’s firm at least £20m for design work on hideous colour schemes. N26, Germany’s largest online challenger, has been told by the German financial regulator, BaFin, to improve its IT systems to prevent money laundering.

Lex, Bill and Marcus highlight yet again the incompetence of the regulators and ineffectiveness of new regulations. So large and cumbersome are these (more rules were created between 2009 and 2015 than in the previous 200 years) that, perversely, it makes them easier to avoid. In the case of Wirecard, BaFin, the government and the Bundesbank threatened to prosecute the journalists who lifted the lid on its fantasy accounts.

Banks will always be unstable because of the genuine genius of fractional banking. Early bankers realised that depositors were unlikely to withdraw their money simultaneously, so only a fraction of deposits are backed by cash. The excess deposits are then used to lend, invest or speculate. Fractional banking is always at risk from a sudden loss of confidence, worsened by stupid loans or borrowing from the wholesale markets (in other words, other financial institutions), which can suddenly cut off credit. This helped bring down our introductory trio and, earlier, Northern Rock. Yet banking is changing at breakneck speed. The consequent uncertainty is one reason why many banks are dirt cheap.

Fintech is finding its feet

New tech-savvy competitors are one threat. Even at the turn of the century banks were wedded to the one-stop shop model, cross-selling a range of financial products. It never worked because the products were often poor and overpriced. New tech disrupters, sometimes selling a single product, have stolen much bread-and-butter business. Wise, for instance, founded in London in 2011, is an international money-transfer company. Its first-year turnover was £8m. Last year sales reached £4bn – per month.

Similar firms are murdering the high-fee, low-service foreign-exchange business of mainstream banks. Six-year-old Revolut is solely a tech-bank. It offers many financial services, is expanding overseas and already has an estimated 16 million customers. These new companies specialise in providing user-friendly and instant access via mobile phone or tablet, keen pricing and transparent fees. For anyone with any technical nous and anyone under 45, transferring money, or buying insurance or shares with lengthy paperwork at the branch of your local bank, is anathema.

The technology problem is also internal as most banks underinvested for decades. As a result, every takeover leads to a collapse in their computer systems. Having been bought by Spain’s Banco Sabadell in 2015, TSB’s future was destroyed in 2018 by a botched IT “migration” costing over £200m in reparations. Sabadell has forlornly sought a buyer, but has no chance of recouping its £1.7bn purchase price.

Yet the greatest threats to incumbent banks lie elsewhere. The core business of banks remains lending out their depositors’ money. The key metric in this respect is the “net interest margin”, or NIM, the difference between the interest rate paid on deposits and the rate charged for loans. With near-zero interest rates and fierce competition, NIMs are tight; witness the many sub-inflation mortgage offerings.

Worse, shadow banking has taken away much of banks’ core business. Providing finance for projects was once the exclusive preserve of banks. No longer. Non-bank finance and shadow banking is not dodgy geezers offering loans in cash, but rather pension funds, insurers and private-equity groups putting their spare money to better use. So my local solar farm, for example, was financed by pension funds and has been bought by an insurance company that needs a reliable income stream. Another major threat to banking is digital currencies. Cryptocurrencies’ underlying technology – blockchain, the digital ledger – is of potentially enormous value in terms of speed, security and traceability.

Central banks and governments have belatedly realised that they are potentially losing control of money and payments systems, not to crypto bandits, but to foreign giants and non-banks beyond their remit, such as Amazon or Google. Big Tech is seeking to develop blockchain technology; no wonder, then, that the major central banks are urgently looking into “central bank digital currencies”, or CBDCs (see page 16). These are hugely controversial, as potentially the blockchain allows governments to be aware of – or stop – your every financial transaction (hence China is trying to develop CBDCs as fast as possible), while in theory making the prime raison d’être for banks – taking deposits – more redundant than steam trains.

Poor sentiment has produced bargains

So why invest in banks? One reason is that they are cheap for no good financial reason save historic sentiment, trading well below book value, a good test of cheapness. Loan-to-deposit ratios are at prudent levels. After the shock of 2008, much higher reserve requirements have been imposed to act as buffers against any downturn; balance sheets have rarely been stronger. Scandals notwithstanding, risk controls have slowly improved: artificial intelligence has the potential to make them better still. With technology, banks are belatedly playing catch-up, hiring staff better trained in coding and computer skills. JPMorgan spends $11bn a year on technology. A fifth of its 225,000 staff are technologists. Others have realised they must follow. The advantage of the disrupters is ebbing.

Controversially perhaps, banks have had a huge windfall from the pandemic. Only the large incumbents could process government support. They kept economies ticking over. But at the same time the smarter banks realised their business models could and must change more quickly. Trends before the pandemic, such as home-working, will now race ahead. Branches will be closed at record rates, whatever the grumbles from politicians. Many are divesting whole business lines where profitability has been poor. The one-stop shop is truly dead.

For years banks have struggled to deliver on promises to reduce their cost-to-income ratios. Costs are dominated by staff and premises; fewer branches mean fewer staff and premises. Today the skylines of many major cities are dominated by trophy headquarters and financial skyscrapers such as NatWest Tower or Canary Wharf in London. Many, if not most, are redundant. The potential impact on costs and profits is spectacular.

Finally, there are five bonuses around the corner. Banks can be winners from the likely return of inflation: as bond yields rise so their NIMs should improve. Secondly, as the pandemic ends, demand for loans for housing, other durables and business is recovering sharply. Yet the real profit boost will come from (unusually) prudent loan-loss provisions. Many banks were over-providing for loan losses pre-pandemic. Provisions increased sharply, but as they are written back, profits will soar. Moreover, many banks have considerable surplus capital. The scope for large and rising dividends is the best of any sector. Finally, the advantages of incumbency are enormous.

What next for insurers?

By contrast, the outlook for the other half of finance – insurance – is less clear. This sector suffers from many of the same threats as banks, but has fewer options. Insurance is about pricing risk, so it is the most data-intensive industry on the planet. Insurers are giant tech firms. The problem is that many are very dozy giant tech firms. The property and casualty business of insurance companies accounts for about one-third of their global premiums (or income), but less than a third is comprehensively computerised.

A Deloitte survey of 32 UK insurance firms found a clear correlation between profitability and technology talent, and that the UK was lagging behind in attracting and retaining skilled staff. Only a quarter of employees possess digital or analytical skills, with a mere 12% of staff employed in these two roles. Yet over half of all staff in international tech giants have these skills, with a third in digital or analytical roles. Insurance brokers are even worse. A mere 6% of their staff are employed in digital or analytic jobs.

Change is coming. Globally, surveys show about a third of all insurance companies are looking to sell off less profitable/non-core businesses and to ramp up their technology expenditure and increase their merger and takeover activity, often to acquire such expertise. The spur for change is nimble new tech companies using big data, the better to price risk, policies and pay out faster.

In the UK “insuretechs”, such as FloodFlash, use algorithms to anticipate flooding and after the recent Yorkshire floods the firm was paying out within ten hours. Wrisk provides rapid and flexible car insurance. In America companies such as Hippo (home insurance), Lemonade (insurance for tenants) or Oscar (health) are eating the larger companies’ core businesses. As if this were not enough, insurance companies are compelled to hold large capital reserves to cover future payouts, much of which has to be held in the highest-rated bonds. These yield nothing. Cyberattacks, increasing climate and ecological risks and a tougher approach by many courts are all difficult headwinds.

But it’s not all gloom. Insurers are adept at raising premiums and shrugging off huge losses. They are also clever at selling you products you didn’t know you needed. Millions of travellers will buy “plague cover” now that it is less urgent to do so. Takeover activity will be rife and will bolster stocks. Capital buffers and reserves are high and the scope for chunky dividends is almost as good as at the banks. And some will adapt, ditch their arcane practices and make better use of data and tools they already own. The banking and insurance sectors are probably the world’s least popular, except perhaps for coal mining and, unlike many, offer excellent or reasonable value. Lex, Bill and Marcus loved their banking friends, who loved them back. I’m less passionate perhaps but am equally amorous for financial gain from stockmarket anomalies.

What to buy now

Although I have extolled the new technology upstarts, I do not advocate buying any. Most are losing money and I’m not smart enough to distinguish the few swans from the ugly ducklings. For a global spread the sole UK financials investment trust is the Polar Capital Global Financials Trust (LSE: PCFT). Well-diversified with a 2.6% yield (likely to rise fast) and trading on a small premium to net asset value (NAV), it looks a sensible bet.

A more interesting, but riskier trust is the £1.1bn, three year-old Chrysalis Investments (LSE: CHRY), which has a very heavy weighting towards unlisted fintech-related companies before they come to market. Performance has been good, yet it trades on a 3% discount to NAV. The negative, in my view, is the egregious performance fee. There is a large range of insurance equity funds. The best-performing is also run by Polar Capital, the Polar Capital Global Insurance Fund F class. Since 2010 the NAV has handsomely exceeded its benchmark and index.

Because I believe the value and gains in financials are clear and probable respectively and many of the best opportunities lie in the underperforming and beaten-up UK market, I prefer individual stocks that are large household names. The big six UK banks have put aside £96bn for loan losses, twice their already high pre-pandemic levels, and hold £32bn of excess capital.

Their credit models will all but force them to release these by way of dividends and/or buybacks. Firstly, consider Barclays Bank (LSE: BARC). This is despite its paranoid CEO who was fined £642,000 by the Financial Conduct Authority, the City regulator, in 2018 for trying to hunt down a whistleblower. The most recent quarterly results beat analysts’ forecasts by a third and its Tier I ratio – or capital buffer – is a whopping 14.6% of risk-weighted assets. Barclays has proved European banks can make money from global investment banking and plain vanilla, basic banking.

Lloyds Banking Group (LSE: LLOY) is entirely plain vanilla with an even higher Tier I ratio of 16.1%. It, too, reported sharply higher first-quarter profits of £1,283m, an increase of 60%. I have been buying both at prices above and below today’s levels. Like Lloyds, NatWest (LSE: NWG) was also bailed out by the government, whose 60% stake will act as a drag as it is drip-fed into the market, so the stock requires more patience. It, too, is storming ahead, with first-quarter profits of £964m compared with the consensus expectation of £536m. Of the large UK banks, it appears to be making the fastest progress in upgrading technology and building cybersecurity.

Overseas there are many other opportunities, but given great value at home, why bother? But I do have a large holding in Bank of Ireland (LSE: BIRG). It was mulched in the 2008 meltdown, but is now well capitalised. It and Allied Irish Banks have the Irish market to themselves these days as rivals have disappeared, so they enjoy cartel-like pricing power. I have not given multiples or yields for any of the above because the pandemic has made the former temporarily meaningless. The latter are currently subject to government controls. But around ten times and 4.5% plus are prudent guesses for 2022. All trade well below book value.

The topic of negative interest rates has been hanging over the Bank of England like a bad smell for quite some time.

Negative interest rates sound weird, but they mean exactly what they say. If you’re a saver, you get charged for the privilege of lending money to your bank (ie keeping it in a bank account). If you’re a borrower (or an ordinary one at least) – ah, well not so fast.

The occasional lucky person in Denmark now gets paid to borrow money to buy a house, but Denmark has had negative rates since 2012. I can guarantee you that if they were introduced in Britain, you’d be getting charged on your savings from day one, whereas you’d be waiting a lot longer – maybe forever – to get paid on your mortgage.

So it’s a good thing that they’re highly unlikely to ever arrive here.

Why central banks are like superstar footballers (they wish)

The topic of negative interest rates won’t go away. It’s not entirely clear what they do that printing money can’t do in a less disruptive manner, and it’s not clear that they’ve done much for the countries that have implemented them (Denmark, Sweden, the eurozone and Japan) other than suppress their currencies. That can be a useful side-effect – but it’s hardly something the UK needs right now.

So there’s an argument for dismissing them out of hand. There are other tools in the tool box. Why does the Bank of England even need to keep coming back to the topic?

However, it’s not that simple. Markets price in expectations for the future. So the Bank needs to worry about managing those expectations as much as it needs to worry about the actual operations it conducts. In fact, playing mind games with the market is the biggest part of any central bank’s job.

Mervyn King (who arguably wasn’t great at this side of market management while he was in charge of the Bank) had a famous football analogy all about this. I’m not that interested in football, so my summation may lack poetry, but King talks about Diego Maradona managing to convince all the defenders in his path that he’s going to go left, then right, and then he just runs straight down the middle and scores.

Mario Draghi was the master of this stuff when he was at the European Central Bank – it’ll be interesting to see if all that geopolitical poker playing experience pays off for him while he’s running Italy.

Anyway, the point is that you have to convince markets that you’re ready for all eventualities, and also that you’re not taking your eye off the ball. Say the Bank just turns around and says: “Negative interest rates are off the table”. Markets will immediately interpret that as a hawkish sign. In other words, they’ll view the dismissal of the tool as a sign that the Bank is thinking about tightening monetary policy.

So the Bank has to at least keep the option open. That’s why it said yesterday that the banks should prepare themselves for negative interest rates to be imposed in six months’ time. But it won’t actually do it unless it needs to. And it doesn’t think it will need to, because when you look at the Bank’s forecasts, it turns out that it expects the economy to make a solid comeback in the second half of the year. As Chris Giles notes in the FT, the Bank “expects the recovery to make up any loss of output in the first quarter by the end of the year”.

Even with all this equivocation, markets took this as good news. The pound shot up, having been weakening against the dollar in the morning. And gilt yields headed higher too (when gilt yields rise, it’s a sign that markets are more bullish on economic prospects).

In short, the Bank wants to keep negative rates on the table, as much so it can threaten markets with the idea as actually commit to it. But unless something really surprising happens (I accept that this can’t be ruled out) then it won’t be using them.

There’s an easy way to bet against negative rates

As an investor, if you agree that it’s unlikely that negative interest rates will ever be an issue in the UK, then one way to bet on that outcome is to invest in the banks. Banks don’t like negative rates. The main reason – or the one that’s cited most regularly – is because they make their profits from the gap between the rate at which they borrow money from the market, and the rate at which they lend it to customers.

Don’t get me wrong. You still make a profit if you borrow at a very negative rate and then lend at a slightly less negative rate. But the fact that rates have turned negative implies that the economy is doing badly. That in turn implies that the yield curve (the gap between short-term and long-term interest rates) is going to flatten. That means that the profit margin to be had by borrowing at a long-term rate and lending at a short-term one is going to be squeezed.

So that’s one reason that negative rates are bad for banks. The other reason is a bit more prosaic, but one that I think is perhaps under-emphasised. And that’s the fact that most banks don’t really seem to be ready to implement negative rates. That would mean faffing about with back-office systems and bits of IT that are already causing many high street banks the occasional embarrassing tech problem.

I’m not suggesting for a moment that negative rates would be a Y2K moment for traditional banks, but let’s be honest here, they’re not exactly up there with Amazon when it comes to their digital customer service.

Anyway. Long story short, if you agree with the Bank of England in that you think that negative rates won’t be needed here, and that the UK economy is going to do pretty well once the vaccine is rolled out, then sticking some money into the banks seems a good play on that.

We’ve mentioned Lloyds (LSE: LLOY) a few times here (full disclosure: I own it myself), and it was one of Jim Mellon’s favoured picks in his recent interview with Merryn (nicely timed, it came out literally before the first vaccine good news broke). However the others will benefit just as well, so I wouldn’t worry too much about buying specific ones, just get exposure to the sector.

We’ve looked at ways to play this and the wider rebound in the UK economy in MoneyWeek regularly over the last six months or so, and we’ll be looking at it again. Get your first six issues free here if you haven’t already subscribed.

Lloyds Banking Group has “poached” HSBC’s Charlie Nunn to be its next CEO, replacing outgoing boss António Horta-Osório, “one of Britain’s best known executives”, say Harry Wilson and Stefania Spezzati on Bloomberg. This reinforces Horta-Osório’s strategy of making a “bigger push into managing money for individuals” in order to diversify the bank’s revenue: Nunn is HSBC’s head of wealth and personal banking.

Lloyds shouldn’t assume that boosting sales by expanding wealth management services is a surefire route to success, says Lex in the Financial Times. Even if it does become one of the top three providers in the UK, it will be “tough” to make a lot more money from it given that fees in the industry are in long-term decline and top-quality wealth managers “remain costly”. Meanwhile the bank will have to deal with the effects of Covid-19, which has wiped out “the income equivalent of 40% of the past year’s cost base”. Given these problems, “a recovery to pre-pandemic levels of business” may be the best it can hope for.

An opaque transition process

The situation is also complicated by the fact that despite the supposedly “rigorous” selection process, Lloyds is not only unable to say “when Nunn will actually be joining” but also “remains unsure as to when Horta-Osório is off”, says Ben Marlow in The Daily Telegraph. It has already admitted that “there may be a period where neither of them are running it”, with chief financial officer William Chalmers stepping in as an interim CEO. Still, maybe Lloyds shareholders should be thankful that Horta-Osório isn’t staying on forever. The share price has halved since he took over.

The delay won’t stop Nunn from having to deal with some potential public-relations disasters next year, says Kalyeena Makortoff and Julia Kollewe in The Guardian. Chief among them is the fallout from a £245m loans scam run from the Reading branch of HBOS, which Lloyds took over in 2009. While six of those involved in the crime have been jailed, Lloyds is “still trying to complete a compensation programme” and is awaiting the results of an inquiry into allegations of a cover-up. Nunn is also likely to face continued criticism over his pay, even though it is lower than Horta-Osório’s package, which prompted “stinging criticism” from MPs.

Good public relations is particularly important given that Lloyds, like other banks, faces a nasty dilemma thanks to the “pile of bad debts” from the various emergency-loan schemes, says Katherine Griffiths in The Times. While the government made it clear that it would guarantee the loans, the terms and conditions require lenders to “try to recover them before they can claim on the guarantees”. But if they push too hard for repayment, they face a “public backlash”. Either way, Nunn can expect “uncomfortable” public appearances before the Treasury select committee and “behind-the-scenes pressure” from ministers about how to treat customers.

The Bank of England is working out the details of a deal that will allow the retail banks to start giving money to their shareholders again. So long as net lending continues to grow, and capital ratios remain robust, they will be allowed to restore their dividends. That is a significant reversal. At the height of the Covid-19 crisis in the spring, the Prudential Regulation Authority wrote to the main banks asking them to cancel any remaining payouts for 2019 and for the whole of 2020. In recent weeks both Barclays boss Jes Staley and Santander’s Ana Botin have called for an end to the ban in public, and now it looks as if, subject to a few conditions, that will be allowed. HSBC said this week that it was likely to start paying a dividend again soon.

A monstrous imposition

Cancelling the dividends took a heavy toll on the share prices of all the main banks this year. From 130p before the crisis, Barclays slumped below 100p before recovering slightly. Lloyds went from 63p at the start of the year to below 25p. NatWest (formerly RBS) dropped from 240p to below 100p, and HSBC from close on 600p in January to below 300p. That is a terrible performance. But then what could be expected? If a company is not allowed to pay out dividends it is hard to see any point in owning the shares – and we can hardly blame investors for selling out. It would help both the banks and the wider economy to restore those dividends as quickly as possible. Here’s why.

First, it is not the job of the Bank of England or its supervisory arm to control payouts to shareholders. The ban should never have been imposed in the first place. Sure, if the banks had been behaving recklessly and heading towards collapse, then it would have been reasonable to stop that. But that wasn’t happening. The main banks were chugging along fine, and making profits, much as usual. In its third-quarter results published this week, HSBC made more than £3bn in profits. If it wants to pay some of that out to its shareholders, there isn’t any reason why it shouldn’t. Likewise, Barclays made profits of more than £600m in the third quarter. Why shouldn’t shareholders get a slice? The ban on dividends was in truth more a PR stunt designed to pander to public opinion than it was anything to do with “prudential regulation”. It is not up to regulators to decide how a business is run or what it chooses to do with the money it makes. That is up to its owners and managers.

It’s not just the banks that are hurting

The second point is that the policy weakened all the retail banks. A bank with a plunging share price and unhappy, disgruntled shareholders looking for an exit, is not going to be a very happy place. The CEO will be under pressure, confidence will be damaged and staff will be worried about their jobs. A bank in those circumstances is not going to lend more, or launch new products, or offer help to customers in trouble. To get out of a recession you need healthy, buoyant banks – and you don’t create those by wrecking their share prices.

Finally, the dividend ban weakened the whole stockmarket as well. Retail banking is a major component of the FTSE 100 index. The high street banks are among its biggest companies. Hammer their share prices with dividend controls and it is not very surprising that the entire index quickly found itself under pressure. UK equities have performed far worse than most major rivals, and that is a big part of the explanation. Just as significantly, the banks represent a major part of the total dividends paid out by the FTSE 100. Of the ten FTSE companies paying out the biggest total dividends in 2019, two were retail banks: HSBC, with a total payout of more than £8bn; and Lloyds, with a payout of more than £2bn. Strip those out of the total, and the dividend yield on the whole index takes a significant hit. Investors then have less money to spend, and less to re-invest, and that hurts the whole economy. The sooner dividends are restored, preferably without any conditions attached, the better for everyone.

Despite a “once-in-a-lifetime crisis”, Barclays has delivered “forecast-beating profits”, says Ben Marlow in The Daily Telegraph. That is due to its investment bank, which is “firing on all cylinders”. The shares rose by 7% on the news.

With boss Jes Staley pledging to “hang around for several years yet”, it looks as though activist shareholder Ed Bramson’s “hostile” campaign to get rid of Staley and move Barclays away from investment banking has been a “complete failure”.

The latest results show the benefit of having a “diversified business model” rather than narrowly focusing on retail banking.

Not so fast, says Lex in the Financial Times. Over the past year Barclays’ share price has largely been determined by the performance of the overall European banking sector, which has been hit by fears of a second lockdown. So, unless bond yields change tack and rise, pointing to “strong economic recovery”, it is “hard to see” the stock rising further.

Indeed, the “surging” investment bank may already be “running out of steam”, with sales in the last quarter 16% below the average of the two previous quarters, says Liam Proud on Breakingviews. What’s more, a few good quarters don’t make up for the “sub-par” returns that it has generated over the past few years. Over the last 19 quarters the unit actually “destroyed” value due to its low return on equity. With the board already engaged in “succession planning”, a candidate “less attached” to the markets business would be the best choice to succeed Staley.

Claims that some of the world’s largest banks “moved large sums of allegedly illicit funds over nearly two decades”, despite “red flags” about the origins of the money, caused shares in the sector to fall on Monday, say David Pegg and Julia Kollewe in The Guardian. Barclays, HSBC and Standard Chartered were among those hit by the leak of thousands of documents showing $2trn (£1.55trn) of “potentially corrupt transactions” between 1997 and 2017 that passed through the US financial system.

For HSBC investors in particular, these headlines may feel unpleasantly familiar. Eight years ago, the bank was fined nearly $2bn, and forced to agree a deferred prosecution agreement by the US Department of Justice, for “providing banking services to drug cartels and other criminals”, says Katherine Griffiths in The Times. Its Swiss subsidiary was also hit by claims in 2007 that it had been helping clients to dodge taxes. The latest allegations could lead to a “flurry of legal claims” against it from the victims of the fraudsters whom it supposedly helped move money.

An overreaction

Calm down, says Liam Proud on Breakingviews. While it’s true that banks “could improve their systems for spotting money laundering”, the behaviour is “less scandalous than some of the headlines make it sound”. This is because the allegations are based on “suspicious activity reports” (SARs) that the banks must file with the authorities every time they think that criminal activity could be going on. Anti-money laundering systems “catch many legitimate transactions”: one estimate is that 90% of SARs turn out to be false positives. So it’s standard practice for banks to report – rather than block – them.

This report looks like the least of HSBC investors’ worries, agree Margot Patrick and Frances Yoon in The Wall Street Journal. A bigger concern is that HSBC could be put on an “unreliable entities” list in China that “would threaten the bank’s growth plans in retail banking and in the country’s securities markets”. China’s Ministry of Commerce has said such entities could “face limits on investment and staff in China”. While no companies have been put on this list yet, China’s state-owned media have named HSBC as a possible candidate.

Any action by China against HSBC would be particularly damaging given that HSBC “has invested heavily in the mainland”, says Lex in the Financial Times. China also contributes $1.5bn worth of pre-tax profits, at a time when HSBC’s earnings in the rest of the world have fallen. Having alienated Europe and America, by publicly supporting Beijing’s new security legislation in Hong Kong, the loss of Chinese support would leave it “friendless”. It’s therefore no surprise that its shares “are trading at levels last seen in the 1990s”, a demonstration of why businesses that have become “political shuttlecocks” are “not worthwhile investments”.

An unexpectedly steep plunge in earnings, with first half pre-tax profits falling by 65% to $4.3bn, has prompted HSBC to announce that it will “accelerate” the axing of 35,000 jobs, says the BBC. The bank says bad loans linked to the coronavirus could reach $13bn (£9.8bn) as more people and businesses are now expected to default on their repayments because of the pandemic. HSBC has granted more than 700,000 payment holidays on loans, credit cards and mortgages. It has also been hit by low interest rates, which squeezes profit margins on the loans it provides.

The job cuts are likely to end up going even further, says Liam Proud on Breakingviews: the investment banking business is the only part of HSBC “that’s really growing”. However, not only is investment banking “hardly a dependable earner”, but its “stellar” performance also can’t offset a “slump” in retail and commercial banking revenue. This leaves cost reductions as “the only lever available” to help HSBC achieve its goal of a 10%-12% tangible return on equity by 2022. CEO Noel Quinn will need “much more” than the 7% year-on-year reduction he’s already achieved.

A bigger headache than Covid-19

HSBC’s size means that it has been in the “eye of the Covid-19 storm” and has been hit particularly hard by government pressure to “support struggling businesses and stretched households”, says Ben Marlow in The Daily Telegraph. Still, in terms of HSBC’s long-term direction, Covid-19 is almost a “sideshow”, since the process of navigating “rising tensions” between Washington and Beijing is providing it with an “even bigger headache”.

There is “no easy fix” for the geopolitical predicament HSBC finds itself in, says Alistair Osborne in The Times. But the decision of its Asian head Peter Wong to sign a petition backing China’s intervention in Hong Kong has “cranked things right up”, as well as alienating its customers in Hong Kong, which currently account for a large chunk of profits. With the bank looking “too big to manage” a breakup seems increasingly attractive, especially as the “pretence” that HSBC can “breezily” operate in markets that “politically collide” has “slipped”.

Still, at least HSBC’s shareholders can console themselves that they are not alone in their misery, say Harry Wilson and Stefania Spezzati on Bloomberg. Write-offs at the UK’s six biggest banks so far this year “roughly equal Barclays Plc’s current market value”.

For example, Lloyds expects to set aside “between £4.5bn and £5.5bn pounds this year”, while Barclays has taken a £1.6bn impairment charge. More misery may be coming with Deutsche Bank estimating that UK banks “might book as much as £40bn in provisions over two years”. No wonder shares in HSBC, Barclays, Lloyds and NatWest “have all performed worse than their European peers this year”.

In the three weeks since the UK voted to leave the European Union, shares in challenger banks Aldermore and Shawbrook have dropped by 32% and 40% respectively. These banks, relatively new to the market, are not yet especially well known. But they have spent the past few years quietly positioning themselves to fill the gaps left by high-street lenders, offering bank accounts which pay a higher-than-average level of interest and also providing niche mortgage products. Are their current low share prices a sign to steer clear, or is it time to buy?

Before 23 June, the argument for owning these mortgage specialists was "simple", says Lex in the Financial Times. They focused on the "fastest-growing lending niches" (such as buy-to-let mortgages) and had a projected return on equity in the mid-teens, "more than double some of their bigger rivals".

Aldermore saw profit before tax rise by 88% to £94.7m in 2015, and processed net loans to customers of £6.1bn, up 28% from the year before. "These specialist challenger banks have been such a success because of their deliberate focus on under-served markets," says Ian Gordon, banking analyst at Investec. For example, 60% of OneSavings Bank's gross loan book is made up of lending for buy-to-let and "small and medium enterprises" (SMEs).

As well as tapping into these under-represented areas of the market, challenger banks have largely managed to avoid recent mis-selling issueswhich have hit the big banks, such as the payment protection insurance scandal and associated fines. (Although Shawbrook will be hit by a £9m "bad loans" charge in the second half of this year, after it was discovered some of its loans didn't meet lending criteria.)

However, post-Brexit, the challenger banks have fallen victim to their own success in a way. As we pointed out last week, the Bank of England has warned that challenger banks are the most vulnerable to a post-Brexit downturn, precisely because they have been willing to make these sorts of riskier loans in the first place.

Overall, the smaller banks have lent less than mainstream banks to the commercial property sector, for example (a mere £17bn relative to big banks' £85bn) but loan-to-value (LTV) ratios are higher. This means it would take a smaller fall in prices to put these loans into negative equity. And looking beyond Brexit fears, the government's recent crackdown on the buy-to-let industry might also have had an impact on share prices.

However, the sharp fall in the bank's prices does seem overdone. As Lex points out, to get from Aldermore's current book value to the one implied by its current share price, broker Numis reckons that bad-debt charges would have to rise 28 times the reported 2015 figure. Lex also draws attention to mortgage specialist Paragon's experience during the financial crisis in 2008/2009. At the time, Paragon reported impairments of 1.7%.

But actual losses peaked at 0.33%. LTV ratios in buy-to-let mortgages are now lower than in 2008, with average debt interest covered almost twice over by rental payments. It is also highly likely that interest rates will stay low for the foreseeable future, which implies that borrowers will continue to take out cheap mortgages and remortgage their properties.

But "even though we reckon a recession has been well priced in", says Emma Powell in Investors Chronicle, "the issue with these challenger banks is they are an almost one-way bet on the direction of the property market". The industry thus relies on a robust UK economy with rising demand for loans (before even taking into account market saturation and competition), and may not be a bet for the long term. However, at these prices, they may well be worth a punt as Lex concludes, "yes, lenders probably face a downturn. But investors are pricing in a disaster."