The global financial crisis of 2007/2008 affected may of us and we continue to feel the effects today. Investors lost confidence in the financial sector as a result and it fell off the radar of many for a number of years. However, the sector has seen something of a renaissance over the past couple of years and has been boosted by rising interest rates and the prospect of a less restrictive regulatory regime in America.
What is the financial sector?
The sector contains companies that provide financial services to retail customers and businesses around the world and includes well-known names such as Bank of America and the Prudential. Whilst the business models of the constituents differ, all act as a financial intermediary in some form or other. For example, banks take in customer deposits and then loan them out to individuals and businesses in need of capital and asset managers allocate the funds of their clients by investing in stock markets. The financial sector is often referred to as the 'nervous system of capitalism' and despite the difficulties experienced over the course of the last decade, it is an essential part of any modern day economy.
Are the shackles loosening?
Following the global crisis, many countries introduced legislation to ensure that financial institutions would be better prepared for any future shocks to the banking system. This has been particularly noticeable in the US where in 2010 the Dodd-Frank Wall Street Reform and Consumer Protection Act in respect of bank oversight was ratified. An extremely comprehensive piece of legislation where one of the key components was the introduction of an annual stress test to ensure that banks had adequate capital to withstand severe financial or economic stress.
Whilst helping to stabilise the financial system, Dodd-Frank has also significantly increased the cost of compliance and regulatory reporting. Adding these costs to the increased capital adequacy requirements affected equity valuations - less money is available to develop and grow businesses.
The pro-growth agenda now prevalent in the US could mean that a lighter touch is used in interpreting rules and regulations. For example, the stress test is required to be taken annually but Dodd-Frank does not spell out what needs to be included specifically. Costly inclusions could therefore be dropped which will free up more capital for investment which could lead to better returns for investors.
Naturally, it is impossible to forecast what lies ahead for the sector however it is clear today that financial institutions are in much better shape than before the financial crisis. The problems that developed in 2007/8 were primarily due to a lack of transparency and trust in the financial sector which ultimately resulted in poor money supply and the well-documented collapse of some very well-known institutions. Today, however, balance sheets have been repaired and transparency in the system (whilst not perfect) has been restored. Combined with potentially less stringent regulations fund managers are identifying investment opportunities. If you would like more details on funds that invest in this sector please contact us for more details.
Information in this article was accurate at the date of publication March 2018.