Bad debts, weak cap­i­tal lev­els hurt­ing Europe's banks growth

The Pak Banker - - FRONT PAGE -

Euro­pean banks are hav­ing a hard time mak­ing money. The 12 largest lenders earned 18¢ on av­er­age for ev­ery $100 in as­sets last year, while their six big­gest US ri­vals made 92¢. Three Euro­pean gi­ants-Credit Suisse, Deutsche Bank, and Royal Bank of Scot­land-each racked up bil­lions of dol­lars in losses in 2015. RBS has lost money ev­ery year since the 2008 cri­sis.

The predica­ment has put the mar­kets on edge. Euro­pean bank stocks are down an av­er­age of 18 per­cent this year as of March 1, com­pared with a loss of 7.4 per­cent for the Stoxx Europe 600 in­dex. More dis­con­cert­ing is the jump in the cost of fi­nan­cial con­tracts that pro­tect bond­hold­ers if a bank de­faults. In­surance on the se­nior bonds of Deutsche Bank, for ex­am­ple, has more than dou­bled in price this year.

Which prompts some ques­tions: Is the fall in Europe's bank stocks a mat­ter of in­vestors wak­ing up to the re­al­ity that, in a post-cri­sis world, bank­ing will be a slower-grow­ing, lower-earn­ing busi­ness? (Not nec­es­sar­ily a bad thing.) Or is it a sign that the banks are weak enough to pose a risk again to Europe's econ­omy and fi­nan­cial sta­bil­ity? The an­swers ap­pear to be yes and yes.

Banks need to bol­ster their cap­i­tal po­si­tion to get safer, but the dearth of prof­its is mak­ing that more dif­fi­cult. "We've stayed away from Euro­pean banks ever since the fi­nan­cial cri­sis," says Lucy Mac­don­ald, chief in­vest­ment of­fi­cer for eq­ui­ties at Al­lianz Global In­vestors. "And un­til they re­ally get to grips with their cap­i­tal po­si­tion and bal­ance sheets, then there is no real need to be there as an eq­uity in­vestor." Cap­i­tal, in a nut­shell, is what stands be­tween a bank merely los­ing money and go­ing in­sol­vent. It's mainly share­hold­ers' eq­uity, the money raised by ei­ther is­su­ing stock or re­tain­ing prof­its. Share­hold­ers don't have to be paid back when busi­ness goes bad, whereas de­pos­i­tors and bond­hold­ers de­mand it. The more a bank's busi­ness has been funded with eq­uity, or cap­i­tal, the safer it is from go­ing bust. Banks on both sides of the At­lantic have been forced by reg­u­la­tors to beef up cap­i­tal since the 2008 cri­sis. (Be­fore, many had as lit­tle as 2 per­cent of as­sets fi­nanced by eq­uity.) In part be­cau se Amer­i­can reg­u­la­tors have taken a stricter line, U.S. banks have been quicker than the Euro­peans to get on top of the prob­lem. By one mea­sure, the cap­i­tal of the top U.S. banks av­er­ages 6.6 per­cent of to­tal as­sets, com­pared with 4.5 per­cent for the big­gest Euro­pean banks. (Banks of­ten cite cap­i­tal of 10 per­cent or more, af­ter weight­ing some as­sets dif­fer­ently based on risk. Cal­cu­lat­ing cap­i­tal ra­tios us­ing to­tal as­sets re­lies less on banks' own risk es­ti­mates.) Two of France's largest banks, BNP Paribas and So­ciété Générale, have cap­i­tal of only 4 per­cent of to­tal as­sets. Deutsche Bank sits at the bot­tom of the list of Europe's large banks, with 3.5 per­cent; its shares are down about 22 per­cent in 2016 so far. "Banks that the mar­ket deems to have less cap­i­tal than oth­ers will have trou­ble in terms of their stock prices," says Nikhil Srini­vasan, chief in­vest­ment of­fi­cer of Ital­ian insu re r As­si­cu­razioni Gen­er­ali. Deutsche Bank of­fered last month to buy back some bonds, and it found few tak­ers.

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