Sentiment toward the global banking sector was extremely poor to start the year, owing to a variety of factors, but reversed sharply in recent weeks as the latest news and data seemed to alleviate investors’ worst fears.

Broadly speaking, investors saw threats to banks’ abilities to grow profits amid a slowing global economy, historically low government bond yields, broadening central bank adoption of negative deposit rates, expectations of lower for longer oil prices, increasing regulation, and ongoing litigation costs. These threats also renewed concerns over whether some banks are adequately capitalized to withstand the next crisis. Divestments by Middle Eastern sovereign wealth funds, which have been major shareholders of certain large US and European banks since the global financial crisis, were also likely partly to blame for the sell-off.

Through its trough on February 11, the MSCI World Banks Index returned -22.4% since the start of the year and -30.4% since its July 22 peak in local currency terms, compared to returns for MSCI World of -12.4% and -16.4% over the same periods. These outsized losses for bank shares were followed by subsequent data releases and announcements that suggested not all of the concerns were as bad as feared, or less bad for banks in certain countries, leading to a 14.7% rally for banks from the close on February 11 through March 4, compared to 10.2% for MSCI World. While the global banking industry faces many common challenges, considering region- and country-specific issues suggests that banks in some markets are better positioned than others.

In the United States, investor concerns include falling long-term rates and a flattening Treasury yield curve (reflecting market expectations for a more dovish Federal Reserve) that could pressure banks’ net interest margins over time, as well as exposure to the troubled energy sector. While the systemically important banks have only limited exposure to oil & gas producers, loan loss provisions have been increasing, and the prolonged oil price slump has heightened concerns about the potential for negative second-order impacts on loan books if the commodity and manufacturing downturn spills over into commercial real estate or auto loans. Still, US banks have meaningfully reduced leverage and boosted capital since the crisis, and both changes should put them on better footing to weather the next downturn.

In Europe, concerns about banks’ balance sheet health returned after some large banks posted poor fourth quarter earnings results and issued negative forward guidance, threatening capital cushions and creating a spike in bank credit spreads as a result. European banks have been slower to deleverage compared to their US peers, partly because they have not rationalized their business models to fit the new regulatory environment to the same extent. The Eurozone follows different banking rules than those shared by Switzerland, the United Kingdom, and the United States, which has resulted in a different definition of regulatory capital. Specifically, to plug capital holes in Eurozone bank balance sheets the European Banking Authority adopted its own unique form of additional tier-one capital called contingent convertible (“CoCo”) bonds, instruments that mandatorily defer coupon payments if certain statutory levels of capital are not maintained or, in a worst case scenario of severe capital losses, can be written down or converted to equity, thus diluting existing shareholders. Recent profit warnings, the opacity and complexity of the rules governing these instruments, and their limited liquidity have created a negative feedback loop between their prices and those of common shares.

Ongoing nonperforming loan (NPL) issues have hurt bank shares in peripheral countries such as Italy, given uncertainty around new rules requiring creditors and depositors to be “bailed in” to future bank rescues. European laws have also tied the Italian government’s hands from effectively addressing the NPL problems at the country’s banks. Another issue has been Southern European banks converting deferred tax assets to credits that are then counted toward regulatory capital; this practice has arguably left them with thinner capital cushions in the event of further stress and has served as another obstacle to writing off impaired assets. Bank margins in some European countries, for example Spain, are more vulnerable to negative policy rates because they are more reliant on retail deposits for funding, giving them limited ability to cut deposit rates. Spanish and Italian banks also have higher exposure to variable rate mortgages on the asset side. Additionally, Spanish and Portuguese banks have exposure to struggling Latin American markets like Brazil.

In the United Kingdom, some banks are suffering from reduced profitability due to troubled expansions into emerging markets and commodities, with a couple recently announcing dividend cuts. Certain British banks are also among those that continue to be ensnared in lawsuits regarding past business practices, with related costs an ongoing drag on profits. The upcoming referendum on EU membership has also spooked investors—a “Brexit” from the European Union could threaten the competitive advantage of British banks given London’s status as an international financial center.

Turning to Japan, the Bank of Japan’s negative interest rate policy could hurt Japanese banks due to their sizable holdings of Japanese government bonds, and the uncertainty and potential hit to confidence caused by the unexpected policy shift. In addition, Japanese lending rates are among the lowest in the world, leaving Japanese bank margins particularly vulnerable to negative interest rates.

The global banking sector has become both more competitive and more heavily regulated since the global financial crisis, against a backdrop of slowing economic growth and extraordinary monetary policy. Recent financial results were a reminder that banks’ profitability potential could be diminished going forward. None of the issues discussed here are necessarily new, and bank stocks’ recent rally suggests they may have reached oversold levels, but the sharp underperformance and subsequent outperformance of bank stocks in recent weeks and months reminds us they are in many ways leveraged proxies for growth. Thus, their share price movements, more than those of other cyclical sectors, often reflect investors’ shifting outlooks on the overall economy.

Michael Salerno is a Senior Investment Director on Cambridge Associates’ Global Investment Research team.