Morningstar has enhanced the Morningstar Economic Moat Rating for banks with the addition of a banking system stability score. In the June 2015 Financial Services Observer—“Where the Wide Moats Are: An Analysis of Banking Systems Lends Clarity to Our Bank Moat Methodology,” Morningstar equity analysts evaluate the strengths and weaknesses of banking systems in 22 countries and their direct effect on the economic moats, or sustainable competitive advantages, of banks operating in those countries. As a result of the research, Morningstar upgraded eight banks to wide moat status.
Morningstar’s global equity analyst team analyzed the stability of each country’s banking system by assessing factors in four areas: economic, political, competitive, and regulatory. Morningstar then gave each country’s banking system a rating of Very Good, Good, Fair, or Poor. The ratings are as follows:
- Very Good: Australia, Canada, and Switzerland
- Good: Belgium, Chile, Hong Kong, Singapore, and Sweden
- Fair: China, Colombia, Denmark, France, Germany, Japan, Mexico, the Netherlands, Spain, the United Kingdom, and the United States
- Poor: Brazil, India, and Italy
Stephen Ellis, Morningstar’s director of equity research for banking and financial services, said, “We examine the strength of banks’ traditional financial intermediary businesses—chiefly retail and commercial banking—and of non-intermediary business, like investment banking and wealth management, which can impact a bank’s moat. We also introduce a rigorous analysis of the banking systems in which banks operate, which is critical to our confidence in the sustainability of a bank’s excess returns and evaluating the likelihood of value-destroying events.”
Morningstar’s new banking system stability scores were part of Morningstar’s broader effort to expand upon its existing framework for evaluating the strength and trends of economic moats for the banks it covers around the world. Morningstar Economic Moat Ratings indicate the sustainability of a company’s competitive advantages, and Morningstar® Moat Trend™ Rating shows whether the sources of competitive advantages are growing stronger or weaker. Morningstar evaluates multiple potential sources of economic moat across seven common business lines and assigns Economic Moat Ratings as Wide, Narrow, or None.
As a result, Morningstar analysts upgraded eight Economic Moat Ratings from Narrow to Wide: Banco De Chile, Banco Santander Chile, Bank of Nova Scotia, Royal Bank of Canada, Svenska Handelsbanken, Toronto-Dominion Bank, U.S. Bancorp, and Wells Fargo. In addition, 10 other banks saw an upgrade or downgrade to their Economic Moat or Moat Trend ratings.
Additional key findings of Morningstar’s Financial Services Observer report include:
- Banks with Wide Economic Moat Ratings are associated primarily with high-quality banking systems. The higher quality and more stable a system a bank operates in, the lower the hurdle needed for the bank to earn a Wide Economic Moat Rating. The eight banks that now have a Wide Economic Moat Rating are generally domiciled within banking systems that Morningstar analysts rate as high quality, such as Canada, Chile, and Sweden.
- A strong economy doesn’t necessarily translate to a high-quality banking system. For example, China, Germany, and the United States are considered to be dominant economies but their highly competitive environments and regulatory issues lead to Fair banking system ratings.
- Diversification doesn’t necessarily add to a bank’s moat, and frequently detracts from it. While most large banks operate as universal banks—banks that participate in a number of banking businesses, generally including retail, commercial, and investment banking—they tend to be less moaty than their stand-alone retail and commercial operations. In many cases, these bank's non-core business are either less inherently moaty than retail and commercial banking—for example, life insurance—or where the bank has fewer competitive advantage, such as investment banking.
An excerpt of the June 2015 Financial Services Observer is available here. A video summarizing the findings is available here.
