European banks are between a rock and a hard place. Photographer: Hannelore Foerster/Bloomberg
The world is now a full decade beyond the great financial crash that saw sub-prime lending tear into global financial services and morph into Europe’s sovereign debt crisis.
However, in the decade since then the regional economy of Europe has only registered growth above 2.0% for 34 months or 28.3% of the time. In contrast, the U.S. has enjoyed growth over 2.0% for 75 months, i.e. 62.5% of the decade.
Banking is at the heart of any free market economy and the crisis highlighted the existing relationship between financial systems and the real economy. The EU financial landscape is highly diverse with each country applying its own separate framework as to how their respective financial system relates to the real economy.
European and American banking systems diverge
Banks and the business of lending to the private sector occurs via the capital market and straight forward bank lending. Due to the shift towards markets in the U.S. from the 1990s onwards and the tilt toward bank loans in the EU post the launch of the Euro in 1999 one can see a dramatic difference in the two banking systems. That gap has steadily widened over the past decade.
The capital markets have proven to be a more efficient means for larger corporations to raise finance whereas smaller concerns prefer bank loans. Whilst the economy in Europe remains lacklustre there appears to be a limited prospect that the ECB will be able to end the negative rate policy anytime soon and so encourage a recovery in bank interest margins.
Certainly, the last actions of Mario Draghi would appear to simply confirm the challenges ahead so making it increasingly difficult for European banks to meet their required hurdle rates and deliver an acceptable level of return on assets and equity.
The consequence is that European bank shares have sunk to levels not seen since 2008 and many are trading firmly below book value. The market is sending loud message that the sector needs to be reformed and shrunk.
Research by Algebris Investments reported by Euromoney on November 4 revealed that the cumulative market capitalization of the top 25 European banks has slumped to roughly the same as just one major U.S. bank i.e. J.P. Morgan Chase.
In investment banking and capital markets it looks even more troubling for the Europeans as the combined market capitalization of four of Europe’s investment banking leaders, namely (in $ billions): Barclays ($37.44), Credit Suisse ($31,66), Deutsche Bank ($7.86) and Union Bank of Switzerland ($47.77) i.e. in total, $124.73 billion is less than the smallest of the three big American universal banks, Citi at $163.37 billion.
Put that in context, since 2014, U.S. banks’ market share in investment banking and trading in the European markets has, according to Euromoney, risen from 31% to 40%.
Banking union in the EU
One logical first step that could help underpin the fightback of the European banks, or even see the evolution of real continental champion, would be a common deposit insurance scheme to strengthen and complete a banking union with the EU.
German Finance Minister Olaf Scholz has a view of how European banks can succeed. (Photo by John ... [+]
German Finance Minister Olaf Scholz said on Wednesday the EU needs to seek a realistic structure for EU-wide bank deposit reinsurance and increase activity on banking projects. If there were a failure in this regard it would leave the EU and its banking system exposed to: "being pushed around on the international stage."
The urgency was being accelerated as a result of Brexit and the potential loss of activities and the financial connections that stem from London.
He added: "The need to deepen and complete European banking union is undeniable. After years of discussion, the deadlock has to end."
European finance is far from unified
The joint deposit guarantee mechanism has been under consideration for several years and always proved a controversial topic with the Germans. Their main concern is that German savers will be left exposed to shore up all and any problems that befall financial institutions in Southern Europe.
Scholz has tried to pave a way through the impasse by suggesting Germany could abandon its resistance to the system if several modifications were adopted.
In a publication titled “Position Paper on the Target Image of the Banking Union" Scholz has proposed a "European Reinsurance System" for bank deposits that would stop a run on credit. That necessitates a move toward an EU bank deposit reinsurance program to bolster existing national deposit insurance schemes.
If only it were that easy. The fact is that European financial markets are divided with too many hurdles that prevent a free-flowing river of liquidity and capital. In addition, the member states of the EU treat their banks differently when it comes to taxation. That makes for an extremely uneven playing field and so ill equips European banks to take on their U.S. peers.
Could it be that really is a new opportunity for the European banks? Olaf Scholz has given the idea a significant shove in the right direction and one can be hopeful as the new President of the European Commission, Ursula von der Leyen, has openly declared her view that complete banking union within the EU is a high priority.
