One of the constants of banking crises is that there is no sustainable recovery until the financial sector has been repaired, says the International Monetary Fund’s Dominique Strauss-Kahn.
US banks have been able to shore up confidence in their prospects (for now) by raising capital privately and passing a stress test. But when it comes to recognising losses, reducing leverage and stocking up on capital, “eurozone banks are in denial”, says Pierre Briancon on Breakingviews.
European banks were always more highly leveraged and exposed to emerging markets than their US peers. But there has been no continent-wide stress testing and investors are in the dark as losses look set to pile up. Germany’s Bundesbank hasn’t published stress tests for the country’s banks, says Wolfgang Munchau in the FT. “I am not surprised.” They would show that the banking system was “insolvent”.
Last week the European Central Bank (ECB) gave a reminder that the recession is far from over. It reckons that eurozone banks have taken just over half their overall likely credit-crunch losses, with around $280bn, mostly from bad loans rather than toxic securities, still to go.
To add to uncertainty over capital adequacy, most of Europe’s big financial groups “employ aggressive accounting practices” that may mask their true condition, says the FT’s Lex.
If European banks are indeed undercapitalised, the lending squeeze in Europe (which accounts for 66% of the fall in international bank lending since last summer, says Gerard Lyons of Standard Chartered) seems likely to worsen, exacerbating the recession and causing more bank losses in a vicious cycle.
So far, the ECB’s pledge to provide unlimited liquidity hasn’t encouraged banks to lend, says Capital Economics. Credit standards continue to tighten and annual lending growth to the private sector may turn negative by the summer. “The risk is that the eurozone has yet to feel the worst of the credit crunch.”
The prospect of more bad news from financials bodes especially ill for Europe. Morgan Stanley says financials make up 23% of the MSCI Europe index, against 13% in the US. This exposure is Europe’s “biggest down-side risk”. Pan-Europe may be historically cheap compared to the US. But the outperformance of Europe this usually heralds seems unlikely to occur anytime soon.