E.U. BANKS STILL POSE SYSTEMIC THREAT / THE FINANCIAL TIMES

July 21, 2013 1:36 pm

 

EU banks still pose systemic threat

 

By Christopher Thompson

 

 

Europe’s banks need to shrink their balance sheets dramatically to ensure the continent can withstand another financial crisis, according to an analysis by Royal Bank of Scotland.

Eurozone banks must shed at least €2.7tn in assets by 2016 for their balance sheets to be “sustainable”, RBS economists have calculated in a research note.

European bank assets and liabilitiesTo enlarge graph click here

 

The sector’s assets are worth about €33tn currently, or nearly three and a half times the single currency zone’s annual gross domestic product.

“If you have a banking crisis and banks are three times the size of their underlying economy, then governments will not be able to support them all,” said Alberto Gallo, head of European credit research at RBS.

“[Europe’s banking system] is the biggest in the world and arguably too big . . . in Japan, Canada and Australia the banking sectors are about twice the size of the economy, while the US is around the same size [as the economy].”

Sincé mid-2012 eurozone banks have reduced their balance sheets by €2.4tn according to data from the European Central Bank in Frankfurt. However, there is “at least €2.7tn more to go” according to RBS – a reduction that would bring banks’ combined assets down to about three times eurozone GDP.

“For European banks there has to be a period of shrinkage,” said Vinod Vasan, head of European financial institutions’ capital markets at Deutsche Bank. “The banks need to be smaller one way or another – but if they can manage it they can also be more profitable.”

But as European banks deleverage, such as by selling loan books, there are knock-on effects to the real economy.

“It’s a catch-22: if you delever too much too quickly you risk going into an accelerated credit crunch. But if you don’t, you risk having a system which is problematic in the long run,” said Mr Gallo. “Today, deleveraging is happening unevenly in Europe: too quick in the periphery, too slow in the core – generating what [ECB president Mario] Draghi calls financial fragmentation.”

Banks’ deleveraging has led to bond issuance by European financial institutions dropping to its lowest level in a decade. The fall also reflects the increased risks of creditors being “bailed-in” if a bank fails, following Europe’s overhaul of the way banks are rescued in the event of a default.

 

While banks have also made early repayments to the ECB of cheap funding taken out under its crisis-fighting long-term refinancing operations, small and medium-sized businesses, particularly in countries like Spain, complain they cannot access bank finance.

 

Combined with the continuing recession, critics suggest the banks are more focused on deleveraging than increasing the amount they lend out, which could help kick-start an economic recovery.

 

Copyright The Financial Times Limited 2013.