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Some of the oldest financial houses are at the eye of a new financial storm
IF THE start of the year has been desperate for the world s stockmarkets, it
has been downright disastrous for shares in banks. Financial stocks are down by
19% in America and 32% in Japan. The declines have been even steeper in parts
of Europe. Greek banks shares have plunged by over 60% since January 1st;
their Italian counterparts have dropped by 39% (see chart). A fall in the
overall European banking index of 27% has brought the sector close to the lows
it plumbed in the summer of 2012, when the euro zone was threatening to
disintegrate until Mario Draghi, the president of the European Central Bank
(ECB), declared he would do whatever it takes to save the euro.
The distress in Europe encompasses big banks as well as smaller ones. It has
affected behemoths within the euro area such as Deutsche Bank which fell by an
extraordinary 9.5% on February 8th as well as giants outside it such as
Barclays (based in Britain) and Credit Suisse (Switzerland).
The apparent frailty of European banks is especially disappointing given the
efforts made in recent years to make them more robust, both through
capital-raising and tougher regulation. Euro-zone banks issued over 250
billion ($280 billion) of new equity between 2007, when the global financial
crisis began, and 2014, when the ECB took charge of supervising them. Before
taking on the job it combed through the books of 130 of the euro zone s most
important banks and found only modest shortfalls in capital.
Some of the recent weakness in European banking shares arises from wider
worries about the world economy that have also driven down financial stocks
elsewhere. A slowdown in global growth is one threat. Another is that the
negative interest rates being pursued by central banks to try to prod more life
into economies hurt banking profitability. A retreat in Japanese bank shares
turned into a rout following such a decision in late January. Investors in
European banks fret not just about lacklustre growth but also about a possible
move deeper into negative territory by the ECB in March.
But the malaise of European banking stocks has deeper roots. The fundamental
problem is both that there are too many banks in Europe and that many are not
profitable enough because they have clung to flawed business models. European
investment banks lack the deep domestic capital markets that give their
American competitors an edge. Deutsche, for instance, has only just given up on
hopes of retaining a bulge-bracket franchise, despite a less hospitable
regulatory environment following the financial crisis.
Not such a dolce vita
And there are still too many poorly performing smaller banks within national
markets. Although this year s share-price declines have been steepest in
Greece, these largely reflect renewed political tensions over implementing the
country s third bail-out. The banks arousing fresh concern are those in Italy,
whose troubles go beyond an excess of them. One specific worry is the dire
state of the country s third-biggest (and the world s oldest) bank, Monte dei
Paschi di Siena, which has long been in intensive care and whose share price
has fallen by 56% this year. Its woes reflect poor governance, a problem that
plagues Italian banks, many of which are part-owned by local, politically
connected foundations.
A more general worry is that Italy s banking sector as a whole is weighed down
with bad loans which have built up during recent years. Although Italian GDP
has been expanding since the start of 2015, it is still around 9% lower than
its pre-crisis peak in early 2008. This has hurt Italian firms and their pain
has been transferred to the banks that lent to them. Gross non-performing loans
amount to 360 billion (18% of the total), of which 200 billion are especially
troubled.
There is nothing especially new about Italy s high level of non-performing
loans; if the recovery can be sustained they should eventually start to come
down. Moreover, over half of the sourest loans are covered by provisions, which
means that the potential bill is more manageable, at around 90 billion rather
than 200 billion. What has changed this year is a new European approach to
tackling troubled banks, which shifts the burden for bail-outs from taxpayers
to creditors who are bailed in when big losses arise. These rules, which have
come fully into force this year (a few countries applied them in 2015), mean
that senior bondholders and depositors with balances above 100,000 can be
stung when banks are resolved.
Bank bonds are generally held by institutional investors who can look after
themselves, but in Italy around 200 billion are in the hands of retail
customers who were lured to invest in them until 2011 by favourable tax
treatment. These retail bonds would be vulnerable if banks run short of capital
after big write-downs.
This danger was highlighted late last year when four small banks were wound up
in a rush to avoid this year s more stringent bail-in provisions. That ensnared
retail bondholders holding junior debt, who could already be bailed in under
the previous rules. One committed suicide. The furore has unnerved Italians.
Ignazio Visco, governor of the central bank, has said that a less abrupt
transition to the new bail-in regime would have been better.
The strict rules have also curtailed the ability of the Italian government, led
by Matteo Renzi, to calm nerves by excising the bad loans from the banking
system. Instead of setting up a state-backed bad bank to remove them, Mr
Renzi has had to adopt a feebler approach in which the government will
guarantee the senior tranches of securitised bundles of the bad loans.
Investors plainly doubt this scheme will help much, to judge by the performance
of Italian bank shares.
Frustration with European constraints on Italy s attempt to sort out its banks
is one reason why Mr Renzi has been making barbed attacks on the German way of
running the euro area. Such political tension is adding to jitters about
Italian banks. Portuguese banking shares have also tumbled, in part because a
new left-of-centre coalition government alarmed international investors by its
decision to impose heavy losses on some senior bank bonds late last year. In
seeking to transfer the risk of failing banks away from taxpayers to creditors,
European policymakers may have thought they were depoliticising the banks. In
the euro-zone periphery, however, politics is never peripheral.