Amid all the hand-wringing over how to make banks safer, one fact often gets lost: A bank's first line of defense is its ability to raise private capital. When a financial institution gets into trouble, investors should be on standby to recapitalize it if needed. Their quid pro quo: a satisfactory investment return.
The problem is that since the global financial crisis, bank equity has not been a terribly attractive investment. In Europe, banks' annual return on equity sagged during the sovereign debt crisis and recovered to only 6%-7% in the runup to the pandemic. While returns are structurally lower than they were before the crisis as leverage declined, they remain below the level expected by investors for the risk they take. Since 2008, the average euro-area bank has been unable to earn the sector's cost of equity, according to the European Central Bank,