What else is behind the fall in bank share prices?

The crisis demonstrated – and continues to demonstrate – too many banks in the US and Europe privatised profits, successfully arbitraging funding subsidised by taxpayers against highly leveraged assets. When the game changed and their bets went wrong, the massive losses were socialised as the banks failed.

So the challenge for global regulators since the crisis has been to make banks safer while taking taxpayers off the hook when banks do fail.

S&P's US note though makes clear this is far from a conclusive process or even one heading for a clean solution.

“Standard & Poor's Ratings Services hopes to resolve the issue of extraordinary government support for the eight US global systemically important banks (G-SIBs) by the end of the year," S&P said. “The move would depend on whether we believe regulators have put in place an effective plan for resolving systemically important institutions - without providing them extraordinary support."

What S&P ultimately decides to do with its ratings – which are instrumental in determining what banks pay for funding – remains dependent on what the US government comes up with to protect both the financial system and taxpayers when a big bank fails.

Creating a safer financial system is proving particularly complex and protracted but in the meantime the uncertainty and lack of resolution has its own immediate impacts.

Compliance costs in the financial system have consistently ratcheted up since the crisis yet such costs are not equal. Banks can be good at compliance and use it to drive competitive advantages just as they can be good at technology or credit analysis. Or bad.

In Australia, in response to a regulatory push towards higher levels of capital to improve safety, ANZ has raised $A3.5 billion, Commonwealth Bank $A5 billion and National Australia Bank $A5.5 billion.

Yet at one point last week the market had removed nearly eight times this figure from the market capitalisation of the banks. Even with the massive volatility in global equity markets, the sell-off is clearly pricing in something else.

In the view of many watching the markets that something else is an expectation of even more capital raisings in the mid-term – but also the sheer uncertainty of the regulatory outlook. After all, the impact on returns on equity and dividend capacity in themselves are not to explain the fall.

Consider another note from S&P concerning New Zealand banks. With concerns of a bubble in Auckland property in particular, S&P argued New Zealand banking financial institutions face increased risks, accentuated by structural external weaknesses in the broader economy.

S&P lowered its issuer credit ratings on seven New Zealand financial institutions and the stand-alone credit profiles of six.

“The rating affirmations reflect factors specific to each of these institutions, such as our assessment of parent support for the four major banks in New Zealand," the agency said.

The four major banks are owned by the four Australian majors. Those parent banks in turn are all rated equally by S&P and implicit in those ratings is the agency's view – despite assertions to the contrary by regulators and policy makers – that no Australian government would let a big bank fail.

That implicit guarantee is widely considered to be worth up to a couple of notches in bank credit ratings.

Now S&P may be right or wrong on that but the curious thing is once that view cascades down to New Zealand, the ratings of the Kiwi banks diverge. After the latest downgrades, three of the four now have a stand-alone credit profile of bbb+. However, ASB Bank, owned by Commonwealth of Australia, is at a-.

Now a case for a higher rating can be made, given CBA's size and market standing, but it looks like an anomaly when the parents are the same and likely to enjoy equal government support.

While I've used these S&P examples, the challenge of unwinding the complex interplay of regulatory agendas, government policies and market expectations, is much wider than one ratings agency. Yet it will affect how much global banks pay for their funding.

It is also feeding into equity markets. In recent weeks I've caught up with a number of fund managers, as have some of my more senior colleagues here at ANZ, and question one is always “will banks have to raise even more capital?" The follow up though is the one which is probably playing into the added discount: how do we read the regulatory agenda and when will we know the process is over? Or at least clear?

Regarding the US banks, S&P said it may take negative rating actions on bank holding companies before the US Federal Reserve makes its position clear. This is pretty much what the market is doing. Discount now, pay back later.

S&P says once it believes there is an affective plan and the banks have sufficient capacity to absorb large losses – what it calls “banks' additional loss-absorbing capacity" and global regulators call “total loss-absorbing capacity" – it may reconsider.

“If we believe they have developed an effective plan, we will remove government support from our ratings on the eight G-SIBs and factor into our ratings an analysis of the banks' additional loss-absorbing capacity (ALAC)," S&P said.

“This likely would involve incorporating notches of uplift into issuer credit ratings on the banks' operating companies based on ALAC, which would at least offset the current benefit to those ratings based on expected extraordinary government support and could provide uplift to ratings on certain banks."

Little wonder there's uncertainty. S&P is saying “we'll discount now, then have a look at what may or may not happen, then assess whether that is a bigger positive than the loss of government support is a negative". This is the substance of another layer of weakness in the sentiment towards global banking stocks.

S&P's conclusion is one which many share, notably the B20 Financing Growth Taskforce from Brisbane last year, and it is “finalisation of the existing regulatory agenda … is important to remove uncertainty and support banks' financial stability".

Until there is at least some clarity around what finalisation of the regulatory agenda will look like – and anomalies around how the agenda will play out in the real world are resolved – a discount will continue to apply to financial stocks.