Lessons from turbulent European bank stocks

Posted on August 7, 2016

Despite problems at Monte dei Paschi di Siena many European banks are well capitalised©Bloomberg

Despite problems at Monte dei Paschi di Siena many European banks are well capitalised

The first week of August was anything but a summer lull, at least for European banks. The release of the EU stress tests at the end of July was followed by days of see-sawing bank stock prices, with the main index first sliding sharply, then bouncing wildly up and down, before ending last week on a solid ascent. By the time markets closed for the weekend, stocks had on average regained about half of a nearly 10 per cent fall. These are turbulent times to be a bank shareholder. Investors are right to be jumpy even if, unlike in 2008, there are reasons to believe that banks are not about to drag the economies down with them.

While post-crisis headwinds continue to buffet European banks, things are less dangerous than they used to be. Take the three main reasons to worry about Europe’s banks: a stress test widely judged disappointing by market observers; continuing and sometimes mounting concerns about bad loans; and the stress on banks’ business models from the low-to-negative interest rate environment.

    The stress tests leave much to be desired. But consider the road already travelled from a world where bank supervision was only done by national authorities, with no attempt at providing internationally comparable data, and often with little interest to expose problems created by their own banking management elites.

    Today, notwithstanding complaints that the regulatory authorities passed judgments that were too forgiving (or no judgment at all), investors do have much more information by which to make their own assessment of banks’ health. The market slide after the stress test results were published shows the data released were informative, even if the official assessment may not have been definitive. The direction of travel, towards more and more comparable information, is right, and the fact that investors can argue the authorities’ views may be too sanguine will put due pressure on policymakers.

    In terms of the substance of banks’ health, this improving transparency helps to establish the great span between individual institutions. While some banks are in deep trouble, Monte dei Paschi di Siena being the most infamous example, others are well-capitalised. The fact bank lending has accelerated at a steady rate across the eurozone for the past year shows banking systems are resilient to any individual banks’ woes.

    And investors are cognisant of this diversity, also brought out by the wide range of bank results released last week — which included good results for several Italian banks that were duly rewarded by stock price rises. All this shows investors are in a better state than before to divide the wheat from the chaff, unlike in the first few years of the crisis when a problem exposed in one bank was seen as a risk to every bank. An implication of this diversity is that authorities’ fear of applying Europe’s new bail-in rules to the worst-performing banks is exaggerated, as Elke König, chair of the European banking union’s Single Resolution Board, has recently argued.

    Finally, there are fears that negative central bank interest rates could have perversely contractionary effects by destroying the viability of some banks’ business models, such as segments of the German banking sector. Fortunately, central bankers are alert to this.

    While, however, European banking has come a long way, national and European authorities still need to up their game. Individual struggling banks cannot be allowed to hold whole banking systems hostage, or militate against the monetary stimulus the economy needs.

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