Burdened By High Debt, European Banks Face A Reckoning: Knowledge@Wharton

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Bank stocks are taking a drubbing globally, but the picture is a bit more glum in Europe. The Stoxx Europe 600 Banks Index is down about 27% over the past 52 weeks, compared to 11% for U.S. bank stocks, as tracked by the KBW Bank…





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If two of Italy’s biggest banks failed, this would represent a crisis of “Lehman-type proportions,” says Allen. And a failure would put the Italian government, already saddled with big problems, under enormous pressure that would spill over globally. “In their financial situation, that would put them over the edge,” he adds.

Recently, the European Banking Authority instituted new regulations aimed at protecting taxpayers from bailing out banks. These “bail-ins” require creditors to take a hit of at least 8% of their liabilities before the banks can ask for state aid. However, “bail-ins” can still “cause bigger problems in the real economy quite quickly,” notes Allen. Considering the size of the three major Italian banks, Allen is skeptical whether the bail-ins would work in this case if all three banks were to collapse.

If two of Italy’s biggest banks failed, this would represent a crisis of “Lehman-type proportions.” –Franklin Allen

Even Germany is not immune from banking troubles. Deutsche Bank, Germany’s largest bank, saw shares plummet as much as 40% this year, dipping even below its low during the 2008 financial crisis. The bank reported a record loss of 6.7 billion euros in 2015 and concerns arose that it could miss CoCo interest payments. But co-CEO John Cryan has said the bank is “rock-solid” — and Germany’s finance minister Wolfgang Schaeuble also has given public assurances.

While the company attributed the loss to restructuring costs for workforce cuts, write-downs and litigation expenses, investors still sold off its shares as they worried that the bank would need to raise new capital. Guillén adds that Deutsche Bank, along with French bank Societe Generale, got too involved with investment banking and suffered losses from bad bets.

Deutsche Bank later announced it would buy back 5 billion euros of its Euro- and U.S. dollar-denominated debt, but investors tendered only 1.94 billion euros to date. “This relatively low investor participation in the public tender offers … reflects improved market sentiment and an investor preference to retain exposure to Deutsche Bank,” the company said in a statement. Goldstein and Allen believe Germany would never let its namesake bank fail.

Guillén believes that Deutsche Bank will be on its feet in two to three years but the Italian, Spanish and Greek banks may not improve for a while. And even if the problems beleaguering these nations’ banks might be specific to their own circumstances, it could affect confidence in bank stocks.

Meanwhile, anxiety over whether the U.K. will stay in the European Union is adding pressure to the economic outlook. “There has been talk that maybe the euro will collapse and some countries will leave the European Union. That will destabilize the currency and destabilize the banks,” Goldstein says. “When you put things together, the fundamentals are unstable.”

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