How much better will it get for the banks?

In a surprising display of arrogance, banks who owe their very survival to healthy doses of taxpayer money have been quick to return to mega-bonuses for their management and staff. When asked how this was possible, the answer has been that "we are paying back the money we got, so we are free to do what we want".

Bank stocks have rebounded strongly since the dark days of last March, when a wholesale collapse of the finance sector was widely feared. And now they are top of the heap again. One could rightly ask how, since the economy has not exactly been vibrant anywhere in the world with the exception of China.

The answer is of course that some of the measures put in place between October 2008 and February 2009 are still strongly positive for the banks' bottom lines. The direct assistance in the form of loans to the banks or capital injections is obviously politically sensitive and something politicians want to get off the table as quickly as possible.

One massive subsidy that is not offensive to the tabloid press is, however, the yield curve. Currently, banks can borrow at 0 percent at the short end of the curve and place at 3.5% or thereabouts in 10 year government bonds. This interest rate differential is a major subsidy and it is ongoing. It is not classified in any public accounts as "subsidy to banks" and is in this way totally under the radar screen.

Currently the yield curves across the world are at their steepest seen in a decade. A step yield curve at the end of a recession is normal, as the markets are pricing in higher short term interest rates going forward´. It also means that the hidden subsidy to the banks presumably is at its highest right now. The bottom line effect for the banks of this is probably at its maximum right now.

Most banks have trading operations. Even if the banks in their advice to clients have missed out spectacularly on the turnaround in the stock markets, their trading operations certainly haven't. The turnover in stocks which slowed markedly last year, did take off in the second and third quarter this year. While we are likely to see a nice turnover in the months going forward, it is unlikely to show the same growth rates, and this implies that the bottom line contribution from trading will have a hard time to continue it growth.

And finally, the mark-to-market valuation of assets was scrapped. It leaves the banks with a considerable freedom to price assets they hold or have a lien on. In practical terms, it means that they are given the possibility to postpone (or maybe even avoid) loss provisions.

It is my perception that banks right in this moment is moving out of a "sweet spot" that has lasted for months. The hidden subsidy from the yield curve will be reduced once the yield curve flattens, the turnover from trading operations will grow less slowly and the loan provisions will slowly grow. The various initiatives towards new, tighter regulation will most likely leave the banks in a situation where they are forced to deleverage further, making it much more difficult to earn the same money as before the recession started.

All of this is unlikely to create problems for the banks' survival going forward. But I do believe that the party for financial stocks may well be over for this time.