Three Risks For European Banks


Authored by Daniel Lacalle,

Loans lead the stimulus plans from Germany to Spain.

Banks in Europe are in much better shape than they were in 2008, however that does not imply they are strong and prepared to take billions of higher risk loans. European banks have minimized their non-performing loans, however the figure is still large, at 3.3% of overall possessions according to the European Central Bank.

The 2 most important steps that governments have used in this crisis are big loans to services partially guaranteed by the member states, and significant out of work subsidy plans to lower the burden of unemployment. Second, up to 20% of the subsidized unemployed workers will probably sign up with full joblessness, which might increase the risk in mortgage and individual loans substantially.

Banks may face a tsunami of problems as 3 elements clash:

  1. rise in non-performing loans,

  2. deflationary pressures from an extended crisis and,

  3. reserve bank keeping unfavorable rates that ruin banking profitability.

We approximate a rise in net financial obligation to EBITDA of the largest corporations of the Stoxx 600 soaring to 3x from the present 1.8 x. This implies that banks might face a wall of delinquencies and weakening solvency and liquidity in the huge bulk of their assets ( loans) simply as deflationary pressures strike the economy, development damages and the reserve bank implements a lot more aggressive however futile liquidity steps and destructive rate cuts.

This mix of 3 issues at the same time might produce a risk of a financial crisis produced by using the balance sheet of banks enormously to deal with the bailout of every possible sector. It may reverse the whole improvement in the balance sheet of the monetary entities achieved gradually and painfully in the past years and destroy it in a few months.

Compromising the balance sheet of banks and hiding bigger danger at lower rates in their balance sheets might be a very unsafe policy in the long run. Governments have pushed banks to give loans to companies and households with extremely challenging monetary conditions and this might return like a boomerang and hit the European economy where 80% of the real economy is financed by the banking sector, according to the ECB.

Federal governments should have taken more sensible procedures and address the covid-19 crisis with tax cuts and grants and not a lot through huge loans, even if those are partly ensured by the states. If the sovereign financial obligation crisis begins to creep once again, there will be a fourth risk that may harm banks and the financing of the genuine economy.

The response of banks in this crisis has actually been positive but might be too much too quickly and clearly, they are taking too much threat at too low rates.

Taking steps to avoid developing a financial crisis from these extreme policies will be important to prevent a larger issue in 2021-2022

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