Spiralling eurozone government bond yields have hogged the headlines as jittery investors ditch sovereign debt. But “the panic engulfing Europe’s banks is no less alarming”, says The Economist. Fuelled by worries over the financial sector’s huge exposure to dodgy government debt, it is now making the crisis even more dangerous.
Banks face a funding squeeze…
The eurozone banking sector, which has around €1.7trn of funding to roll over in the next three years, is having trouble getting hold of the cash. The market for bank bonds is shrivelling. “Just as a boa constrictor… squeezes the life out of its prey, so bond investors… have eurozone banks in their grip,” says Lex in the FT. The banks have raised less than 66% of the $650bn they need to refinance maturing debt this year. According to Citigroup, third-quarter issues were just 15% of the level raised in the past two years’ third-quarters.
Another funding source, the wholesale market, is also drying up. Loans from US money-market funds to French banks, for instance, have fallen by 69% since the end of May, says ratings agency Fitch. Loans to the continent’s banks are down 42% in four months. Banks have also cut back on lending to each other, with interbank lending rates back up to 2009 levels and many banks resorting to the European Central Bank for money. Sometimes they have to pay hefty fees to get hold of the right kind of collateral in the market in order to be eligible for ECB loans. In the meantime, deposits are slipping away. In Italy, non-retail customers withdrew €56bn in the three months to the end of September – a 12% fall in deposits. Given all the above, Europe is suffering a slow-motion bank run.
New European capital regulations will exacerbate banks’ dwindling scope to provide loans. Because raising capital in these rocky markets is virtually impossible, many banks will meet the target ratio (capital as a percentage of assets) by shedding assets. Barclays Capital reckons that if banks improve their ratios purely by shrinking their balance sheets, lending would slide by €3trn, a third of eurozone GDP.
…so they are cutting lending
We are already seeing a credit crunch emerge in Europe, says Ambrose Evans-Pritchard in The Daily Telegraph. The eurozone’s overall money supply is falling as banks retrench. Banks cut their balance sheets by €79bn last month. Mortgage lending saw the biggest drop since late 2008. Banks’ “crash diet” isn’t only a problem for Europe, says Morgan Stanley’s Huw van Steenis. The squeeze “will have a knock-on effect in Asia and the US”. For instance, last week Austria’s central bank told its banks to cut back on cross-border lending, which is likely to undermine lending in eastern Europe, a region highly dependent on eurozone banks. Some banks have withdrawn entirely from markets such as trade finance or aircraft leasing, says Economist.com.
What next?
Beyond the credit crunch, another danger is that banks are now shedding dodgy peripheral debt, raising yields further and fuelling more panic over possible defaults. That in turn compounds fears over bank’s exposure to government debt. As funding continues to be squeezed, one or more banks could fail, sparking further bankruptcies – especially since indebted governments are no longer in a position to prop up embattled lenders. Europe’s leaders are working on ways to address these dangers, says Economist.com. “But it would not be the first time that their efforts are overtaken by events.”