Starting as a credit issue in the subprime segment of the U.S. mortgage market, the worst financial crisis since the Great Depression has now spread to almost the entire global financial services industry. However, we believe that the worst of the global financial crisis is behind us.

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.

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. This could again create a new global financial crisis, challenging the world banking system. Though the European Union is bailing out the country in some way 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.

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.

OPPORTUNITIES

Currently, there are no banks in the Zacks covered non-U.S. bank universe with a Zacks #1 Rank (Strong Buy). However, specific banks that we like with a Zacks #2 Rank (Buy) include Bank of Montreal (BMO), Royal Bank of Canada (RY) and Royal Bank of Scotland Group Plc (RBS).

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), Banco Macro S.A. (BMA), Banco Santander, S.A. (STD), Banco Santander-Chile (SAN), Bancolombia S.A. (CIB), The Bank Of Nova Scotia (BNS), Barclays plc (BCS), Canadian Imperial Bank of Commerce (CM), HSBC Holdings Plc (HBC), Lloyds Banking Group Plc (LYG), KB Financial Group, Inc. (KB), Toronto-Dominion Bank (TD) and Mizuho Financial Group, Inc. (MFG).

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 Latinoamericano de Comercio Exterior, S.A. (BLX) and UBS AG (UBS).Zacks Investment Research