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posted on 10 July 2016

Zombies In Europe

Written by ,

Europe's banks have been back in the crosshair of the markets in recent weeks, with new attention to their multiple problems catalysed by the Brexit vote. The equity positions of many banks has been evaporating while non-performing debt has not diminished and, in some cases, even increased. Greek debt has been continued at face value, for example, by continuing to force more debt on that nation so it can continue payments on old debt.

I spoke on the matter in a brief interview with UTV here:

Now, Bloomberg has put together a (very concise) summary of some of the key problems the banks face:

"Europe's banks have been a focal point of investor skittishness since Britons voted to leave the European Union, but reasons to be worried about financial firms pre-date the referendum. Whether it be the mountain of non-performing loans, the challenge from fintech firms and alternative lenders encroaching on what was once their turf, or rock bottom interest rates eroding margins, the problems facing Europe's lenders are mammoth."

To summarise the whole rotten lot: European banks (as a sector)

  • Cannot properly lend and price risk (hence, a gargantuan mountain of Non-Performing Loans sitting on their books that they can't deleverage out, exemplified by Italian, Slovenian, Spanish, Portuguese, Cypriot, Greek, Irish, and even, albeit to a lesser extent, German, Dutch, Belgian and Austrian banks);

  • Cannot make profit even in this extremely low funding cost environment (because they cannot lend properly, while controlling their operating costs, and instead resort to 'lending' money to governments at negative yields);

  • Cannot structure their capital (CoCos* madness anyone?);

  • Cannot compete with more agile fintech challengers (because the dinosaur mentality and hierarchical structures of traditional banking prevents real innovation permeating banks' strategies and operations);

  • Cannot reform their business models to reflect changing nature of their customers demands (because they simply no longer can think of their customers needs); and

  • Cannot succeed in their traditional markets and services (despite being heavily shielded from competition by regulators and subsidised by the governments).

Instead of whingeing about the banks' plight, we should focus on the banks' resound failures and stop giving custom to the patrician incumbents. Let competition restructure Europe's banking sector. The only thing that sustains Europe's banks today is national- and ECB-level regulatory protectionism that contains competition within the core set of banking services.

It is only a matter of time before M&As and organic build up of fintech players will blow this cozy cartel up from the inside.

So regulators today have two options: keep pretending that this won't happen and keep granting banks a license to milk their customers and monetary systems; or open the hatches and let the fresh air in.

*A contingent convertible bond (CoCo), also known as an enhanced capital note (ECN), is a fixed-income instrument that is convertible into equity if a pre-specified trigger event occurs. The concept of CoCo has been particularly discussed in the context of crisis management in the banking industry. The logic behind contingency convertibles is somewhat inverted from the traditional convertible bond which is exchanged for stock when the stock price rises to a specified value. Instead of converting bonds to common shares based solely on stock price appreciation, investors in contingent convertibles agree to take equity in exchange for debt when the bank's capital ratio falls below a certain point. In a manner of speaking it is a "bail-in" instrument which coverts bond principal to an equity position when equity has "become scarce". Read more at Investopedia.

A previous version of this article (Europe'e Banks: Dinosaurs On Their Last Legs) appeared at true economics 10 July 2016.

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