Companies keep bank profits up

BARCLAYS was the last of the major UK banks last week to report its interim figures for the first half of 2005, following HSBC, HBOS, Royal Bank of Scotland and Lloyds TSB. The results tend to confirm underlying economic trends and so offer a snapshot of the financial health of the UK and global economy.

They are also very important for investors because the banking sector is one of the most significant in the FTSE.

All the banks recorded higher profits than for the corresponding six months the

previous year, ranging from £6bn at HSBC to £1.7bn at Lloyds TSB.

They identified a number of trends that were affecting their businesses, both positively and negatively, but they have all managed to increase total revenues and profits against the backdrop of a slowing world economy.

The headline figures were the large rises in bad-debt provisions the banks had to make as UK consumers struggled to keep up with their repayments.

HSBC increased its to £1.9bn and RBS to £847m., underlining recent surveys that have shown how consumers are retrenching to confront mountains of personal debt they have accumulated.

UK consumers are labouring to service and repay their debts because of tighter monetary policy, moderating earnings rises and a stagnating housing market.

In spite of a deteriorating position in their retail arms, the banks have benefited from an upturn in the performance of their corporate and business divisions.

This paints a contrasting picture of buoyant companies and depressed consumers.

Businesses have continued to borrow to invest because they have now rebuilt their balance sheets following serious indebtedness at the turn of the century, corporate profitability is rising and the stock market is recovering.

The UK banks underline the benefits of diversification and economies of scale as they manage to increase their profits in spite of under-performing areas of their business.

They operate in many different geographical markets, which means that better economic growth rates in some regions can compensate for downturns in others.

For example, HSBC saw strong growth in the US and Asia, which counterbalanced a subdued UK performance.

Similarly, the banks sell many different types of product to many different types of customer.

Barclays saw a decline in profits at its Barclaycard division as bad debts increased, but the overall increase at the company was driven by the strong results from its business and investment banking and fund-management arms.

The banks also take advantage of a larger customer base to sell them more products and to reduce the costs of financial intermediation, which means they can maintain a lower liquidity ratio and therefore make more (hopefully) profitable loans.

Diversification insulates the banks against the vagaries of the economic cycle, which tends to determine their profitability as it puts pressure on margins and undermines the quality of their main assets, loans.

They are not unduly concerned by the current slowdown because it is relatively benign and is happening while interest rates are still relatively low, employment is strong, earnings are stable and the housing market has decelerated, not collapsed.

Last week's decision by the Bank of England to lower interest rates should help the banks and their customers.

They tend to perform better when interest rates are lower or falling because demand for loans from individuals and companies increases.

Their margins expand and borrowers find it easier to service and repay their debts, leading to lower defaults and bad-debt provisions.

Falling interest rates usually herald the start of an upturn in the economy, but they do not always work, can take time and suggest that the economy may need further remedial boosts before it improves.

Happily, many of the banks are not purely focused on the UK.

* Comments to rich@hemans.net. Richard Hemans is a chartered accountant who runs his own business, Zeus Consulting.