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US banks might outperform their European peers, but there’s more cause for comfort than concern

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The global banking space has been weathering a number of storms since the start of the global financial crisis in 2008, the latest being the uncertainty around the U.K. exit from the European Union. Add to that the poor economic outlook and negative interest rates and the pressure is heaped on a bank's profitability.

But while the European banks struggle to keep their share price stable, their counterparts at the Wall Street seem to be doing a much better job.

"European banks have had a particularly tough 2016, with the Stoxx 600 banking sector seeing declines of over 20 percent so far this year," Alex Dryden, Global Market Strategist at JPMorgan Asset Management told CNBC via email.

"This puts the European banking sector on track for its worst year since the depths of the euro zone debt crisis in 2011."

Cause for comfort

Dryden however further explained that despite the sharp pullback in banking share prices, and speculation that investors are not pricing in the impending collapse of one or more European banks, the region's banking system is not on the brink of collapse it found itself at the height of the global financial crisis.

"The cost of buying insurance against European financials firms has ticked up in 2016, but is still below the highs of the euro zone debt crisis. If we dig a little deeper into the balance sheets of European financial companies, there is actually more cause for comfort than concern. These show that European banks have taken significant steps to strengthen their position since the Global Financial Crisis (GFC) and euro zone debt crisis."

But a number of analysts have said that European banks face an entire basket of uncertainties that tend to weigh on their performance. Latest earnings results show that while Deutsche Bank and Barclays have posted better-than-expected results in the third quarter, concerns over their performance in the final quarter of the year and their future continues to loom.

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The situation is however quite different with big U.S. banks such as JP Morgan, Citi and Goldman Sachs that have posted stronger-than-expected profits in the third quarter.

"There are a number of major reasons that we prefer U.S. banks over European banks," Naeem Aslam, chief markets analyst at Think Markets UK told CNBC via email.

"Firstly, it is the interest rate environment which is a lot more favorable for the U.S. banks. The Fed is about to increase the interest rate for one more time this year and this is going to be positive news for them. But if you look in Europe, we do not think that interest rates are going to move higher anytime soon"

Aslam further explained that the fixed income business and their investment arms are performing very well over in the U.S. and this trend could continue.

"As for European banks, they are in process of cutting the fat and still structural reforms remain the key issue. Also, if you look at the number of toxic assets, European banks have an abundance of these, although they are getting rid some of them now. The U.S. banks have strong balance sheets and they are in a much better position. "

Need for deep-rooted reforms

The International Monetary Fund in its latest Global Financial Stability report said that more deep-rooted reforms and systemic management were needed, especially for European banks. The report further stated that European investment banks in general have higher leverage and more compressed risk weightings on assets than their U.S. counterparts, suggesting that they have a more challenging adjustment path.

According to the IMF, the European banking sector faces three major headwinds – these include high levels of non-performing loans, excess capacity in the banking system and the Bank Recovery and Resolution Directive (BRRD) - requires an 8 percent bail-in of a bank's creditors, including very large foreign banks and hedge funds — be applied before taxpayers get put on the hook.

"The return on assets for European banks is structurally low at 0.25 to 0.50 percent, compared with about 1 percent at U.S. banks," the IMF report said.


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