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