In Focus: Giles, last month, you were quite positive about the stability of the financial system. Has this positive trend continued?

Giles Keating: Yes, I would say so. For example we’ve just seen in the United States the government and the authorities saying that some of the big banks can pay back some of the money that was put into the banks by the government. That’s a signal of how things are improving. In addition we’ve seen a lot of private capital being raised for the banks around the world and we are continuing to see quite a lot of issuance in the bond markets. Now having said all of that, not everything is good. Clearly some of the European banks look as though they still need further capital injections. And there are definitely one or two hot spots: For example, some of the Eastern European currencies are looking a bit unstable.

Should we expect further write-offs in the balance sheets of the banks?

Further write-offs are just an inevitable part of the continued process of sorting out the financial system and indeed they could be quite large. However, it looks as though they can be spread out over a period of time. And most of the larger American banks have now got a fair amount, if not all, the capital that will be needed to cover those future write-offs. The same probably applies to most of the British banks, again perhaps not for some of the continental European banks.

How do you estimate the threat coming from the Eastern European banks?

The problems of bad debts from Eastern Europe do impact certain banks in Western Europe quite heavily. But I think the overall scale in the global financial context is not large enough to be destabilizing in the way we saw it at the end of last year.

What about the risks from wrong policies that influence the financial system?

There are always risks from wrong policies I am afraid. Looking back at the credit boom which led to the burst, it certainly was a result of central banks keeping interest rates too low as well as some problems with the regulatory system. This time around, the policy mix of very low interest rates and government capital injections into the financial system seems to have stabilized things. However, there is a certain risk that these kind of expansionary policies will be kept going for a bit too long and that may actually push a little bit too much liquidity into the system.

According to Nobel Prize winner Paul Krugman, some European governments, especially the German, aren’t doing enough to combat the recession. Do you agree?

In the financial sector, it indeed looks as though some of the German banks still need more capital. As for more macroeconomic policies in Germany, I wouldn’t agree with Professor Krugman, and I do expect that the German economy will see a rebound as world trade tends to recover.

Is it a disadvantage that the European Union doesn’t have a common fiscal policy like the US?

Also in the United States there are many complications in the fiscal policies, because a lot of local governments have got into trouble and the central government is actually having to bail them out. If we look at Europe, then we’ve seen a degree of ad-hoc coordination among the large countries like Germany, France and the UK, who have introduced some degree of fiscal stimulus programs. I think in Europe the problem is more at the fringes with some of the smaller countries. Ireland, for example, is under great pressure and may eventually require some kind of financial arrangement from some of the larger countries. How that can be done under existing treaties is still a bit uncertain. But the overall situation is not that dissimilar to what has happened in the United States.

How would you describe the new banking landscape that will emerge after the crisis?

There has been a degree of consolidation which has resulted in bigger banks. We might see more of that. We are also going to see higher capital ratios, as a result of new regulations, but also because shareholders and depositors are asking for it. That means that the banks are going to hold more capital against their assets. In the longer term this will make them more stable. In the shorter term, that tends to inhibit their ability to lend. In general, banks will be less inclined to the kind of highly leveraged transactions that we have seen. But at the end of the day, banking is a leveraged business and that’s not going to change.

The stock market recovery has been quite strong since last March. Have the pessimists been wrong?

So far, the pessimists have indeed been wrong. We’ve now had rises of 40 to 45 percent in the global stock markets from the bottom, and in some of the emerging markets we’ve seen even much larger rises. Although history suggests that there will be setbacks, I think right now there are still a lot of investors who have been left behind by that rally and who are now putting cash into the markets. This is supporting stock markets for the time being. So the risk is rather low that the markets will go back to those lows that we saw in March. Looking ahead over a 12-month period, the balance of likelihood is more on the upside.

In a recent publication, Credit Suisse recommended buying selected value stocks. Why?

Right now the valuation of value stocks is reasonably conservative compared to their earning stream. It’s only as the recovery progresses that the investor focus shifts from value stocks to growth stocks, whose valuation relies more heavily on future growth. In terms of the kind of stocks that we recommend, we have developed a very powerful software tool which enables us to identify the value stocks that meet the particular needs of any client.

Can something similar be said for bonds?

Many corporate bonds still offer reasonable value, although not as good as a month or two ago, when the spreads between the interest rates on corporate bonds and government bonds was wider than it is now. Nevertheless we think there is value offered among quite a range of corporate bonds, both from higher quality issues and some of the lower quality issues. On the other hand, there is a certain threat of further rises in longer-term interest rates that will tend to bring down the prices of corporate bonds. So, careful selection is the key.

Credit Suisse has rather a bearish view on the dollar for the next twelve months. What are the reasons behind this?

Although the dollar does not look expensive against the major currencies, it does look expensive against a large number of emerging market currencies which have not yet recovered the full extent of the losses they made in the crisis. That’s the first point. Secondly, short-term interest rates in the US are below those in Europe, which puts the dollar under pressure. Thirdly, contrary to what people expect, in the last two recessions the dollar actually weakened when the economy began to recover. This is likely to happen again. We can add two further factors: one is the government debt overhand in America which is clearly a concern for investors, as the authorities might be tempted to allow a little bit more inflation than in Europe in order to deal with that. And finally a number of very specific financial flow factors which were supportive for the dollar are now fading away, for example foreign banks bringing money into America to deal with the losses they made. All these factors will undermine the dollar.