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Who would want to own shares in a bank? Rising interest rates should have been a blessing, lifting the income they can earn on assets. But a few banks that had lent and invested freely at rock-bottom rates faced runs, which pushed up funding costs for the rest. More may yet fail. And new regulations, ominously named Basel 3 “endgame” rules, could raise the capital requirements on some American banks by as much as a quarter if they are introduced in their current form in 2025. This would scupper any chance that shareholders can be paid much out of profits, perhaps for years.

Nasty stuff. Indeed, the KBW index of large American bank stocks has shed 15% this year, even as American stocks have risen by 19%. This underperformance, after a decade of mediocrity, means that banks now make up less than 5% of the S&P 500 index of large American firms. Blackstone, a private-markets giant, has a market capitalisation 20% bigger than that of Goldman Sachs. Just about any measure of valuation shows banks to be at or near an all-time low.

Yet being cheap is not the same as being a bargain. Banks are not startups selling a growth story. Nor are they tech firms building innovative new products. Banking is a mature business; its fortunes are closely tied to the macroeconomic environment. Investors therefore look for institutions where profits or earnings might grow in the near future and where those profits may be returned to investors via dividends or buy-backs.

On neither front do American banks look appealing. Net interest income, a measure of the difference between the interest banks earn on loans and that which they pay out on deposits, seems to have peaked. Although rising rates boost income, the climb in funding costs has eaten into this. Customers fled regional banks following collapses earlier in the year and have moved away from all banks in favour of money-market funds, which offer higher low-risk returns. Even in the best-case scenario for America’s banks—a “soft landing” or “no landing” at all, in which there is no recession, few loan defaults and interest rates do not come down much—earnings would probably remain only around their present levels.

Then there are the capital rules. If bankers have to hoard capital in order to boost buffers there will not be much left to pay dividends or do buy-backs. Bankers are concerned that the rules could even spell the end game for their business. Jamie Dimon, boss of JPMorgan Chase, America’s biggest bank, has remarked that less regulated competitors, such as growing private-credit firms, should be “dancing in the streets”. Marianne Lake, JPMorgan’s head of consumer banking, has described the situation as “a little bit like being a hostage”. The requirement was so shocking at first that “even if it changes a bit, you sort of are grateful for that,” she has admitted, despite the pain it will nevertheless cause your company.

The fight over the proposed changes has become ugly. Although bankers typically lobby behind closed doors, the new requirements have pushed them into open warfare. They have pointed out that the proposals would quadruple the risk-weighting given to “tax equity” investments, a crucial source of financing for green-energy projects under President Joe Biden’s Inflation Reduction Act. Some lobbyists reportedly may sue the Federal Reserve for failing to follow due process and argue that the regulator should give people more time to comment once it has been followed.

These tactics could work. The Fed might water down its plans, or a back-and-forth might push the proposals into a grey zone ahead of America’s presidential election. The rules are subject to review by Congress, and it will have few days in session next year owing to the primaries, summer recess and the election itself. As the odds of a Republican presidency rise, so do the chances that a later review would result in much smaller increases in capital requirements.

Still, an investor might feel queasy at making that bet. So one looking at banks might turn his attention to Europe instead. Unlike in America, funding costs have not climbed much, in part owing to weaker competition. The result has been a steady stream of earnings upgrades. After nine years of negative rates the return to positive ones has been “like rain in the desert”, says Huw van Steenis of Oliver Wyman, a consultancy. Extra capital requirements from Basel 3 are more modest in Europe. An investor might want to buy shares in a bank, then. But for the first time in a long time, perhaps he should consider a European one. ■

Read more from Buttonwood, our columnist on financial markets:
Short-sellers are endangered. That is bad news for markets (Nov 30th)
Investors are going loco for CoCos (Nov 23rd)
Ray Dalio is a monster, suggests a new book. Is it fair? (Nov 16th)

Also: How the Buttonwood column got its name