January 31, 2020

Countdown to Brexit: U.K. Banks

by Tajinder Dhillon.

Brexit worries combined with a low interest rate environment, deteriorating GDP growth, and a decline in business sentiment has created a challenging outlook for U.K. banks.  Banks have significantly underperformed the broader market when looking at Datastream Global Indices.

The graph above highlights returns over the last 10 years, with banks achieving a 5.2% total return in comparison to 108.5% for the broader market.

As a result of the low interest rate environment, net interest margin (NIM), the difference between interest charged on loans and paid on deposits, is a key profitability metric for banks has come under pressure.

Further pressure on U.K. banks has come from “ring-fencing” legislation which came into effect in 2019, requiring banks to separate retail banking activities from the rest of its business.  The new regulation has increased competitiveness in the U.K. mortgage market, which will benefit consumers but ultimately hurt bank profitability.

When looking at the current FTSE 100 constituents, U.K. banks have underperformed over the last decade.  Three of the major banks experienced negative annualized growth rates over this time period.  Exhibit 1 highlights Standard Chartered, Barclays, and Royal Bank Scotland experiencing annualized growth rates of -4.4%, -1.0%, and -0.7% respectively.

Exhibit 1: Top & Bottom Performers of FTSE 100 Constituents

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