The global banking industry has been recovering at a slower pace from the worst downturn since the Great Depression that started as a credit issue in the subprime segment of the U.S. mortgage market and ultimately spread to engulf almost the entire global financial services industry. Though the worst of the financial crisis is behind us, there remain major political challenges following the intervention of governments to rescue and stabilize the global banking system.

Although non-U.S. banks are still dealing with liquidity and confidence challenges, governments have taken several steps to alleviate the sector, as banks are the lifeblood of the economy. Consequently, the political interference in the sector has increased significantly over time. The politicization has added to the existing financial risks that banks face.

The political interference will continue to influence banks’ lending decisions to until they repay government money. According to banking regulators, if governments withdraw their support from banks before giving them sufficient time to restore their financial strength, the sector will face another collapse.

Though the industry is in the process of adopting tougher measures to help prevent a recurrence of the global financial crisis and restore public confidence, there remain lingering concerns. However, we believe it would be a perfect time to get involved with non-U.S. bank stocks for long-term investments, as valuations are now comparatively cheaper.

Investors with short-term targets should not go for non-U.S. stocks at this point as the near-term fundamental outlook remains weak — asset quality is expected to continue to deteriorate as individuals and companies default on loans, and revenue growth should remain stretched as loan growth falters and investment banking faces a dearth of new business despite the economic recovery.

Increasing unemployment and sluggish business conditions worldwide are expected to dampen demand for credit, though banks are now capable of lending more. Moreover, these factors will also hurt asset quality and increase losses on the existing “good” loan portfolios. Combined with top-line pressure due to a sluggish economic recovery, non-U.S. banks face a discouraging outlook in the near- to mid-term.

Although the upturn in the banking sector through the remainder of 2010 will vary from country to country, depending on industry circumstances, we believe that banks in stable emerging economies, such as Chile, Brazil or India, may be more attractive investments — similar to what we expect for certain regional banks in the U.S.



However, the recent debt crisis has threatened the Greek economy and the stability of the European Union’s monetary policies. Starting as a solvency crisis of a single country, the turmoil has threatened the entire Euro-zone. This could again create a new global financial crisis, challenging the world banking system. Though the European Union has been bailing out the country to assure creditors that it will not default on its debt, there is no guarantee that the country will be safe as affluent domestic and foreign investors will not stop withdrawing their money from Greek banks, from which they have already pulled out billions.

However, European Union authorities have taken the decision to put more banks through the public stress test in an attempt to reinstate the transparency and trustworthiness of the European banking system. The results of the stress test, which are scheduled to be released in the second half of July, will help the European Union prefigure the depth of the turmoil. Accordingly, the European Union will decide on its further course of action to restore the confidence of investors and the health of the European banking system.

To be sure, banks in emerging economies will face asset quality issues. However, they are not confronted with other significant problems that many of the larger banks face in continental Europe and the United Kingdom, such as toxic securities, dilution from capital raising and dividend cuts/omissions. Moreover, these emerging-market banks generally tend to be well capitalized, aren’t as heavily exposed to property markets, and have significant and generally growing sources of non-interest income.

The Institute of International Finance, which represents major financial institutions in 70 countries, has said in a report that the firms are learning from the crisis. But there are several issues worth considering when investing in these banks:



First, investment in non-U.S. ADR bank stocks entails foreign currency risk. Currently, the U.S. dollar is remarkably volatile against many foreign currencies, which tends to depress the share performance. Importantly, we expect volatility in the stock prices to continue, reflecting economic uncertainty in the coming months and headline risk.



In all, a key determinant for quick recovery will be the quality of risk analysis and how well risk awareness is built into decision-making and incentive policies. So we believe that accumulating larger capital buffers over the cycle and reducing pointless complexity in business will be crucial for the performance of non-U.S. banks. Also, the primary attention of policymakers should be to determine how much longer the fiscal stimulus should continue. The stimulus should continue at least until a clearer sign of economic recovery is visible.

OPPORTUNITIES

Currently, the banks in the Zacks covered non-U.S. bank universe with a Zacks #1 Rank (Strong Buy) are Banco de Chile (BCH) and Banco Macro S.A. (BMA). Specific banks that we like with a Zacks #2 Rank (Buy) include Bank of Montreal (BMO), Banco Latinoamericano de Comercio Exterior S.A. (BLX), Grupo Financiero Galicia S.A. (GGAL), KB Financial Group Inc. (KB), Mitsubishi UFJ Financial Group, Inc. (MTU) and Shinhan Financial Group Co. Ltd. (SHG).

We also like HDFC Bank Limited (HDB) and ICICI Bank Limited (IBN) in India. Both of these banks have recently been emphasizing strong cost controls and improved operating efficiency, rather than growth, as key strategies. As a result, these banks have been able to offset some of the earnings pressure from higher loss provisions due to weakening asset quality. We anticipate continued synergies from these banks’ cost-containment measures and operating efficiency.

There are currently a number of stocks in the Zacks covered non-U.S. bank universe with a Zacks #3 Rank (Hold), including Banco Bradesco S.A. (BBD), Itaú Unibanco Holding S.A. (ITUB), Bancolombia S.A. (CIB), Banco Santander-Chile (SAN), The Bank Of Nova Scotia (BNS), Canadian Imperial Bank of Commerce (CM), Deutsche Bank AG (DB), HSBC Holdings plc (HBC), Royal Bank of Canada (RY), The Toronto-Dominion Bank (TD) and UBS AG (UBS).



WEAKNESSES


We would suggest avoiding banks in Greece at this point. Also, it is better to avoid banks in Great Britain and Ireland, particularly those which have participated in government recapitalization programs and have yet to repay the money. In return for government capital and asset quality protection, these banks are facing government intervention, including limits on dividend payouts and the nomination of board members.



Specific banks that we dislike with a Zacks #5 Rank (Strong Sell) include Banco Bilbao Vizcaya Argentaria S.A. (BBVA), Banco Santander S.A. (STD), Barclays PLC (BCS), Credit Suisse Group (CS) and Westpac Banking Corporation (WBK).Zacks Investment Research