Via Financial Times

More than a decade on from the financial crisis, Europe’s banks are facing a major test of their resilience.

This week growing fears about the coronavirus pandemic and an oil price war prompted a widespread market sell-off. Companies have spent a decade gorging on cheap debt in an ultra-low interest rate environment. A wave of defaults is now likely, and rising loan impairments will hit banks’ already anaemic earnings.

Since their recent peak almost a month ago, European banks indices have plunged 40 per cent in an indiscriminate sell off of financial stocks. This outpaces the 25 per cent fall over the whole of 2018. European bank shares now trade at the lowest level since the 1990s.

The latest slide has cost shareholders about €300bn and left all major European banks trading at steep discounts to their book value. On average, they are now worth at about 0.4 times their net assets, half of the 0.8 ratio for the top six US banks. 

Line chart of Euro Stoxx Banks Index  showing Three weeks of meltdown for Europe’s banks

Despite a series of monetary stimulus measures announced by central banks this week, investors remain cautious. New accounting standards in the US and EU also threaten to worsen the pain, requiring banks to recognise loan losses much sooner than under past regimes.

“European banks remain a lightning rod of negativity, but they are stronger in terms of liquidity and capital than they were in 2008 and 2012”, said Benjie Creelan-Sandford, a banks analyst at Jefferies. 

Leading the decline is French investment bank Natixis, whose shares have lost more than half their value since February 17 amid concerns about large losses in its H2O Asset Management business.

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Italian lender Mediobanca is the worst off when looked at in terms of the market capitalisation decline versus total loans. Its shares have fallen 42 per cent since February 17 on concerns about its ability to absorb more bad loans and a plunge in the value of its holdings of Italian sovereign debt.

Chart showing banks' market cap loss as a share of loans

Dutch lenders ABN Amro and ING have also sold off because of their significant exposures to the energy sector. Meanwhile Germany’s Deutsche Bank has seen its double-digit gains from early in the year wiped out and reversed, and the stock is now trading at a new record low.

European banks have far less room for manoeuvre than their US counterparts in a crisis that could see revenue fall 5 per cent or more this year. By one measure of profitability, their average return on equity declined to 7 per cent last year, less than half the 16 per cent generated on profitability by big US banks, according to data from the European Banking Authority.

Adding to the stock and earnings woes, lenders are reporting a rush of companies drawing on credit lines, notably in the oil, airline, hospitality and healthcare industries. These companies are seeking liquidity to survive a potentially prolonged period of global quarantine.

Nevertheless, Europe’s banks are better positioned to survive the shock this time. Regulators have forced them to build significant loss-absorbing capital buffers, reduce their balance sheet leverage and exit risky activities such as proprietary trading.

Going into the 2008 crisis, the average European bank core capital was around 4 per cent, and today it is more than double that and of a higher quality, according to Citigroup analyst Ronit Ghose. 

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“Unlike 2008, banks are not the cause of this crisis and together with government policy, can be part of the solution,” said Mr Creelan-Sandford of Jefferies.