7 Reasons Why European Banks Are in Trouble, by Philipp Bagus

European banks, especially southern European banks, are one of SLL’s odds on favorites to kick off the next financial crisis. From Philipp Bagus at mises.com:

While the euro crisis seems far away as all Eurozone countries ran government deficits below 3 percent of GDP, there is one problem for the euro that quietly keeps growing: the unresolved banking crisis. And this is not a small problem. The Eurosystems´and euro banks´ balance sheets totaled €30 trillion in January 2018, that is about 291 percent of GDP.

European banks are in trouble for several reasons.

First, banking regulation has become tighter after the financial crisis. As a consequence regulatory and compliance costs have rise substantially. Today banks have to fulfill demands by national authorities, the European Banking Authority, the Single Supervisory Mechanism, the European Securities and Markets Authority and the national central banks. Being at a staggering 4% of total revenue currently, compliance costs are expected to rise to 10% of total revenue until 2022.

Second, there are risks hidden in banks´ balance sheets. That there is something fishy in European banks´assets can quickly be detected when comparing banks market capitalization with their book value. Most European banks have price-to-book ratios below 1. German Commerzbank´s price-to-book ratio stands at 0.49, Deutsche Bank´s is at 0.36, Italian UniCredit´s at 0.23, Greek Piraeus Bank at 0.14, and Greek Alpha Bank at 0.34.

With a price-to-book ratio below 1, buying a bank at the current prices and liquidating its assets at book value, an investor could make profits. Why are investors not doing that? Simply, because they do not believe in the book value of the banks´assets. Assets are too optimistically valued in the eyes of market participants. Considering that the equity ratio (equity divided by balance sheet total) of the Euro banking sector is at only 8.3%, a down valuation of assets could quickly evaporate equity.

Third, low interest rates have contributed to increasing asset prices. Stocks and bond prices have increased due to the monetary policy of the ECB, thereby leading to accounting profits for banks. Monetary policy has, thereby, artificially propped up banking profits during the last years.

Fourth, according to the ECB non-performing loans (NPLs), i.e. loans where borrowers have fallen behind in their payments, amount to €759 bn., that is 30% of the banks´ equity.

To continue reading: 7 Reasons Why European Banks Are in Trouble

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One response to “7 Reasons Why European Banks Are in Trouble, by Philipp Bagus

  1. The situation is probably far worse than what is being depicted here depending on the rules of accounting employed in Europe. My guess is any set of regulations drawn up by a firm named Dewey, Soakum and Howe are unlikely to meet anyone’s standrads except for the mafia or politicians.

    Like

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