David Kuo: Is it time to trust the banks again?

Banks are back in profit but does that mean you should invest?

Back in 2008, not only was the general public expressing a mistrust of banks, but banks were also displaying a wholesale mistrust of each other. They were not only unwilling to lend to consumers, they were also reluctant to lend to their peers. The argument at the time was that if a bank as large as Lehman Brothers could disappear in a puff of smoke, what chance did the likes of Alliance & Leicester have?

Two years on, thing look very different. Central banks have pumped huge amounts of money at very attractive interest rates into investment and retail banks. It is hardly a surprise that banks have grasped the opportunity of accessing cheap money to boost their profits by re-lending at considerably higher rates of interest. Consequently, we have seen many of our high-street banks confidently state that they should be able to meet profit estimates for the full year.

Barclays is expected to deliver full-year profits of £6bn. That is up from about £4bn last year, and three times more than it made in 2008. HSBC, following news of a doubling of pre-tax profits for the half year, looks comfortably on track for annual profits of around £12bn. Standard Chartered, which is based in the UK but operates primarily in Asia, has deftly defied the global downturn. It is expected to announce another year of improved profits. The performance of the embattled state-owned Lloyds Banking Group has improved too. It has swung into a profit for the first half, and could remain in the black for the full year too.

If we look at banks in isolation, then the valuations appear quite reasonable. Barclays is valued at about 11 times its profits for this year, and HSBC and Standard Chartered about 14 times. Looking ahead to 2011, when earnings are expected to improve further, the shares look even less expensive. The valuations of the primarily state-owned banks do not seem too demanding either.

However, it is impossible to look at banks without considering the economic and political risks at the same time. The financial upheaval over the past two years would suggest that in an interconnected global financial market, it would be dangerous to invest in banks without looking at what is happening elsewhere.

Political risks still remain. The Government has already hinted that banks can expect to be clobbered if they reward shareholders excessively at the expense of funding small businesses. There is also the spectre of national debt: what happens if Greece defaults?

The days of big dividend payouts and growth may be over, at least until global economies recover strongly and banks are no longer on politicians' agendas. Until then, yield-hungry investors may want to look elsewhere.

David Kuo is director of investment website fool.co.uk