When I looked at the banking sector twelve months ago in the wake of the rebound we had seen since the lows in March 2009 I struggled to see where any future upside would come from.

The major worries tempering my enthusiasm on the sector was the on-going concerns about the European banking system given that Ireland had only just been bailed out and Portugal was looking increasingly vulnerable with 10 year yields starting to edge up over the 7% level.

In the last quarter of 2010 Standard Chartered stole a march on its competitors by raising capital to boost its capital ratios due to concerns over a funding crunch in 2011 and 2012.
This, as it turned out proved to be a smart move, even if the sector initially started 2011 on the front foot.

Concerns about European banks exposure to sovereign debt, as well as requirements to raise additional capital in line with Basel 3, has seen investors increasingly shun the banking sector over the past 12 months.

Discredited European Banking stress tests have done nothing to assuage investor concerns as the situation on Europe has continued to deteriorate in the face of a disjointed and in some cases incompetent European policy response.
In the second quarter of 2011 the sector broke below its 2010 lows at 4,300 and pushed sharply lower in response to rising concerns about the solvency of the banking sector in Europe and the subsequent bailout of Portugal.
A break below the 3,000 level and this year’s November lows could well trigger further losses in the sector.

In the UK the September’s ICB Vickers Report outlined further steps to ensure that UK banks would not place any new additional burdens on the public purse.
The idea is to ring-fence the retail operations from the investment banking divisions with some commentators arguing that it doesn’t go far enough.

The decision by the UK government to implement these measures in full this week has come under fire from some quarters with the claims that it will hit banks at the worst possible time when they are trying to rebuild their balance sheets, and also coming under pressure to lend more.

This argument is somewhat spurious however given that they will have until 2019 to implement these measures. In any case the outlook for banks across Europe is likely to remain uncertain while the politicians struggle to find a solution to the European sovereign debt crisis.

The reality is with the amount of toxic loans on European banks balance sheets at some point the likelihood of any significant upside in the sector is likely to remain constrained by higher capital requirements at a local and international level, as well as having to write down exposure to European sovereign debt.

The UK banking sector looks set to continue to remain split between the better performers like HSBC and Standard Chartered while on the other side of the coin we have the state owned banks RBS and Lloyds with both banks paring down their balance sheet size, and finally Barclays whose share price has also dived in recent months.`

Lloyds has undergone a torrid time in recent months with concerns about the health of its new CEO, and problems in trying to sell-off a number of its branches to comply with EU regulations.

Since the share price bottomed out in January 2009 at 16p the share price recovered to 2010 peaks of 79p, however since then it’s been downhill all the way, with lows so far this year of 21.60p.

There is potential to go back to the lows of 2009 but unless conditions deteriorate any further that looks likely to be a base in the short term.

Barclays bank underwent the sharpest recovery from its 2009 lows of 47.30p outperforming all its highs rising as high as 394p, after getting a large Middle East cash injection to alleviate the likelihood of having to accept a government bailout.

It has fallen sharply from those 2010 highs, finding support throughout 2010 and the first half of 2011 at the 250p level before finally giving way in July this year to fall sharply lower.
The share price bottomed out around the 133.90p area, however given the banks’ exposure to Europe the bank could well be susceptible to further shocks, which could take it below its October lows.

A move back above 220p, the October highs could well signal some stabilisation in the share price.

Royal Bank of Scotland is the one bank most affected by the Vickers Report after the Chancellor announced plans to shrink its investment banking division.
Plans are being considered for the bank to sell off or shut its stockbroking division. The bank has already shrunk its balance sheet by almost £1trn since new CEO Stephen Hester took over from Fred Goodwin in 2008.

How future changes will affect the share price is hard to quantify despite this year’s share price declines. It would seem the future size of the bank is likely to be of lesser importance than the outcome of events in Europe.
What does seem likely though is that the 10p lows seen in 2009 are unlikely to be revisited unless problems in Ireland, which RBS is heavily exposed to, start to resurface.

This year’s lows around 17p should act as support while a rebound over the 23.55p highs seen this month, could well show some signs of stabilisation.
Lloyds and RBS are the worst performers’ year to date, showing down 65% and 51% on the year to date, followed by Barclays which is down 37%.

Even HSBC, which while exposed to Europe and the UK’s problems, has a much wider Asia focus, is down 27% while Standard Chartered is down 23%.

One thing seems certain given the tight funding problems set to face sovereigns as well as banks in 2012, it remains likely that financials will continue to remain volatile, with prices remaining depressed, while Europe acts as a cloud, while a recovery in Asia is more likely to help HSBC and Standard Chartered than the others.