A decade ago this month, the century-old US investment bank Lehman Brothers declared bankruptcy. It was the largest corporate failure in US history at the time and it marked the official start of the Great Recession.

How have banks, local and foreign, changed over the decade for the better — or for the worse?

Banks, not only in the US but around the world, were at the very centre of the crisis, creating a powerful vortex when they retreated and pulled in not only each other but whole economies.

Behind the banks lay a booming property market, underpinned by the end of the Cold War, global economic expansion, especially in Asia, and the sense that a brave new world had begun.

Lehman Brothers had tried to leverage this expansion aggressively, not only directly but also indirectly with new financial instruments such as mortgage-backed securities and collateralised debt obligations.

One Lehman division provides an apposite example. In 2003, the Lehman home loans division made $18.2bn in real estate loans.

By 2004, this number topped $40bn. By 2006, its two real estate units were lending almost $50bn a month. In 2008, Lehman had assets of $680bn but only $22.5bn in capital, which meant that a 3%-5% decline in real estate values would wipe out all capital.

Chief economist and investment strategist at Investec Brian Kantor says the trajectory of banks, both local and foreign, since the crisis has been mixed. On the one hand, the big banks are more powerful than ever. On the other, the days of lopsided incentive structures and exorbitant rewards for bankers are gone.

Brian Kantor: SA banks saw off the global crisis quite well. Picture: Hetty Zantman
Brian Kantor: SA banks saw off the global crisis quite well. Picture: Hetty Zantman

The mood is much more cautious and the regulatory environment has changed dramatically. Capitalism as a whole got a bloody nose, he says.

In SA, banks had been through a crisis of their own in 2000 and 2001, and consequently they were much more conservatively managed. They saw off the global crisis quite well, says Kantor, and SA held up respectably until the end of the commodity super-cycle in 2011/2012.

And now, a decade later?

An analysis by global advisory firm McKinsey finds that banks are safer but less profitable. The tier 1 capital ratio has risen from less than 4% on average for US and European banks in 2007 to more than 15% in 2017.

The largest systemically important financial institutions must hold an additional capital buffer, and all banks now hold a minimum amount of liquid assets.

Proprietary trading, in which banks traded on their own accounts, has been pared back and the scale and scope of their trading activities have been reduced, decreasing their exposure to risk.

Banks also began to reduce their geographic footprint.

Locally, Standard Bank was the best example. It closed or sold its banks in Argentina and Russia, scaled back its London office and focused its activity on SA and Africa in general.

The new rules were one reason Barclays dropped its investment in Absa, since it was required to report 100% of the risk despite holding only 60% of the equity.

The McKinsey report calculates that the return on equity (ROE) for banks in advanced economies has fallen by more than half since the crisis, and the pressure has been greatest for European banks.

In Europe, the average ROE over the past five years stood at 4.4%, compared with 7.9% for US banks.

Prior to the crisis, the price-to-book ratio of banks in advanced economies was at or just under two, reflecting expectations of strong growth. But in every year since 2008, most advanced-economy banks have had average price-to-book ratios of less than one (including 75% of EU banks, 62% of Japanese banks, and 86% of UK banks), the McKinsey report says.

In SA, the trend has been the same regarding price-to-book ratios even while ROE numbers are astoundingly high in SA compared with international trends.

For example, Standard Bank’s price-to-book ratio hit three just before the crisis — which was at the high end of even the inflated emerging-market standards. It’s now at about 1.7, but ROE of SA banks remains strong at about 18%, according to a PwC banking report.

One of the big changes has been a different regulatory environment, particularly concerning nonperforming loans, which need to be recognised faster.

In India, for example, more than 9% of all loans are nonperforming.

In SA, they are at around 1%, the PWC report says, reflecting the conservative way SA banks are managed.

The biggest change has been in the mood: what the Lehman collapse showed emphatically was that the one thing banks need to protect above all is their reputation.

It is, in a way, their only real asset.