The European banking system is flatlining

The European banking system is flatlining. Main image: Lightspring,
Written by Chris Skinner

Is the European banking system creating issues it can’t handle? Are German banks seriously in trouble? Story by Chris Skinner.

There was an interesting article in The Independent last week about the big banks becoming bigger since the financial crisis hit. The article notes that the big American banks control 70% of all US assets, and that this figure has increased 40% since 2008.

In the lead up to 2008, parallel to increasing debt levels, the size of banks rose sharply, especially relative to the size of certain economies. By 2007, bank assets in many developed countries had reached in excess of 100 per cent of gross domestic product.

A large banking system is not necessarily problematic … But a large banking system creates a number of issues.

Those issues include banks becoming too central to the running of the economy; when the domestic economy becomes too flat, banks use leverage to increase profits; the need for shareholder returns then creates increased risk taking; that risk taking leads to the launch of new financial innovations that are untested and unproven; this leads to too much complexity in the markets and cross-border movements of capital; ultimately it leads to failure, but the banks know that they won’t fail as governments will underwrite them as lenders of last resort.

It’s a kind of vicious rather than virtuous circle: banks take risks which, if they fail, force their government to bail them out.

In the US and globally, the combination of “too big to fail” plus a relaxation in measures designed to modestly reduce the financial sector may be laying the foundation for another financial crisis.

Europe is a basket case

I read this article at the same time as I picked up Handelsblatt’s quarterly magazine. Unavailable online, it had a fascinating article about Europe’s banks featuring content I’d not seen elsewhere. Sure, we know that some of Europe is a basket case – Greece, Cyprus – but Germany? German banks seriously in trouble? OK, I heard the IMF calling Deutsche Bank systemically dangerous, but they’re not going to fail, are they? Well, this article explained the issue well, so here goes.

Total non-performing loans as reported by banks, in billions of euros. Sources: ECB, BloombergFew follow the continued wreckage to the shipping industry with greater alarm than Germany’s banks. A massive lending binge to shipping companies in the years leading up to the financial crises has left some leading banks dangerously exposed. Despite a decade’s worth of debt write-offs and bailouts, German banks still hold some €90bn in shipping loans – around a quarter of the global total – with disastrous consequences as the debts continue to sour. Last month, the country’s largest lender, Deutsche Bank, warned that losses on its shipping portfolio could hit €34m this year, three times the 2016 figure. Rival Commerzbank says it will be setting aside up to €600m to cover possible maritime losses …

Consider the facts. A 2016 KPMG report revealed that one decade after the financial crisis, Europe’s banks still carry non-performing loans – where the borrower is paying no interest and repaying no capital – worth €1tn, almost three times the figure in the United States. In Italy, where the much-publicised woes of the world’s oldest banks, Monte dei Paschi, have threatened to bring down the entire banking systems, a full 15% of loans are now deemed non-performing. But that share is trivial compared to the plight of banks in Greece and Cyprus, where the figure tops 40% …

Share of non-performing loans. Source: World BankTo be sure, the picture if far from uniform. In the Nordic countries, many banks have more or less managed to clear their books of bad debts through sales or write-downs, while in Germany, non-performing loans make up just 3.5% of the total (see chart). But there’s little room for complacency …

The problem is writ large across much of Europe. While the Eurozone and the US both started with similar shares of bad debt during the financial crisis, the share has come down in America but stayed high in Europe (see chart). One reason seems to be that US regulators were tougher in forcing debt write-offs, recapitalisations and even bankruptcies. For the American financial sector, the crisis is effectively over.

Hmmmm … thank goodness for Brexit, I guess.

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– This article is reproduced with kind permission. Some minor changes have been made to reflect BankNXT style considerations. Read more here. Main image: Lightspring,

About the author

Chris Skinner

Chris Skinner is an independent commentator on the financial markets through the Finanser, and chair of the European networking forum the Financial Services Club, which he founded in 2004. He is an author of numerous books covering everything from European regulations in banking through to the credit crisis, to the future of banking.

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