New year, new banks

Dark clouds on the horizon

For eurozone banks, the outlook for 2012 remains as grim as the last 12 months, says SHAYLA WALMSLEY.

Just when it looks as if it couldn’t get much worse for eurozone banks, analysts are warning of further potential shocks.

Some of the shocks won’t be particularly shocking. Few expect Greek sovereign debt bondholders’ “voluntary” agreement on a 50 per cent haircut to be the end of it. Sovereign debt-exposed banks, none too happy about taking haircuts on these investments in the first place, could be facing losses of as much as 70-75 per cent.

October’s revelation of a €106bn capital shortfall across 70 European banks, and the European Banking Authority’s insistence that the 70 meet a 9 per cent threshold on first-tier capital, followed a revaluation of sovereign debt. The broader context is the signal that bonds are riskier than investors had previously thought, points out Guntram Wolff, Deputy Director of Bruegel, a European economics thinktank.

According to Open University economist Alan Shipman, EU governments balked at the prolonged fiscal deficits necessitated by an initial decision to opt for gradual post-crisis bank recapitalisation. The hastily adopted alternative – fast, state-sponsored recapitalisation – will only work “if no-one panics about Italy and Spain in the short term”.

It’s a big “if”. Italy has a public-debt-to-GDP ratio of 120 per cent and an economy that has effectively stalled for a decade. “Without growth, how will it get out of this mess?” says Andrew Gibson, Head of Research at Galvan Research & Trading. “The fractured political system offers little hope for meaningful, painful reforms.“

Spain looks marginally less risky than it did a year ago, with what the EIU forecasts to be manageable government debt by 2016 and – unlike Greece or Italy – a broad political consensus on the need for reform. Yet the cajas are hopelessly exposed to property and local pet projects, and the large banks are likely exposed to the cajas.

Not all eurozone banks are happy about being recapitalised, of course. Portuguese banks until October resisted bolstering their capital via a €12bn government fund because they wanted to avoid handing over part of their capital to state ownership. The fact that they now need to boost their capital by around €8bn to meet EU targets – both to cover their exposure to sovereign debt and to meet the tier-one capital requirements – has made tapping state funds almost inevitable.

In the meantime, a few known unknowns could change the eurozone landscape significantly. One is whether the BRICs – notably China with its “get a job” message to what it sees as workshy Europeans, but potentially also Brazil, India and Russia – will be willing to pay down eurozone debt via the IMF.

“European bank balance sheets are so large that insulating the other countries would require significant money from outside Europe – not these playing-for-time guarantees by a bunch of countries that are basically insolvent in aggregate,” says former central bank economist Birone Lynch.

The current crisis may well accelerate a longerterm trend towards bank disintermediation as banks face increased pressure on wholesale funding.

“My hunch is that you might see an interesting trend towards less bank mediation and more capital market mediation,” says Wolff. “There isn’t much evidence of it yet, but it’s a trend that goes beyond what we’re observing in the eurozone.”

Meanwhile, knee-deep in crisis probably isn’t the best opportunity to catch banks and policymakers with an agenda for long-term reform – but reform will be needed nonetheless. “We need very different stress tests that go in depth into the balance sheet of individual banks and take into account not only the exposure to debt but all their exposures,” says Wolff. “Whether the political will is there is questionable but at least leaders are acknowledging the issues that need to be addressed.”

SHAYLA WALMSLEY is a business journalist.

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