Returns at banks are declining as they increase capital (and hence lower leverage) in response to regulatory requirements. Lower leverage means lower risk. This should translate into a higher P/E multiple which should offset the decline in EPS itself and leave bank prices unchanged at the very least.
An article in FT points out that this is not happening. The markets are not rewarding banks for lowering financial risk. They seem to want the same double-digit returns that banks earned when they enjoyed much higher leverage. Are CEOs of banks not communicating properly with investors? Unlikely. It's just that markets are displaying irrationality:
If social mores were different, an obvious response for most bank chief executives, especially investment bankers, would be:
“You loved this business when it had equity-to-asset ratios of 2 per cent and a 16 per cent RoE. Why do you hate it now that it has 5 per cent equity to assets and a 9 per cent RoE?”
Take Barclays, criticised since the crash for lacklustre returns. In 2006, at the peak of Bob Diamond’s fame and pre-crisis fortunes as head of Barclays Capital, the UK-based bank made £4.6bn profit on average assets of £950bn — a return on assets of 0.5 per cent. In the first half of last year, Barclays made £2.2bn profit; and the business had average assets of £872bn. The annualised return on assets was almost the same. If Barclays in 2015 had operated with the same gearing, or debt-to-equity ratio, as in 2006, it could have declared a 20 per cent RoE for its core operations, rather than the 11.1 per cent it announced.