Should We Be Concerned About Europe's Banks?
24 March 2023
Europe’s banks are facing a range of challenges during a particularly trying economic era, including how to finance the carbon transition, moving away from emergency support funding, enabling the digital economy, and a general economic recovery. The Green Economy team consider whether we should be concerned about the health of Europe’s banks.
The most recent troubles for Europe’s banking sector involved the £2.6bn state-backed rescue of Switzerland’s Credit Suisse, which caused a slump across European banks on Monday 20th March. In the UK, Natwest, Barclays and Standard Chartered were all down by more than 7 per cent with a fall of around 5 per cent for HSBC and Lloyds.
Further afield, Deutche Bank was trading 1.8 per cent lower and UBS, who rescued Credit Suisse, 3.7 per cent lower. The Stoxx Europe 600 Banks Index was down by almost 3 per cent by Monday morning, with additional declines across many of Europe’s top banks. The flurry of spooked investors was sparked by the nature of the Credit Suisse rescue deal, which saw £14bn of Credit Suisse’s bonds, labelled Additional-Tier 1s (AT1s), wiped out. The decision to write Credit Suisse’s bonds down to zero represents the most substantial loss in the AT1 market to date.
Despite what seems to be an incipient European banking collapse, experts are not anticipating a recurrence of the 2008 financial crisis which sparked a global recession.
How does a bank collapse?
Banks tend to collapse when they owe more money than they own. This happens as a result of spooked investors withdrawing deposits prompted by signs that their money may no longer be safe.
In Credit Suisse’s case, the bank had been facing difficulties for years following a long line of scandals, management shifts, billion dollar losses, and unsuccessful strategies. In the space of just a few months last year, Credit Suisse’s wealthiest clients withdrew more than 10 per cent of their money from its wealth management, causing significant issues for Credit Suisse’s cash outflows.
They began selling off their shares in 2021, by the autumn of 2023 rumours of Credit Suisse’s inevitable collapse were circulating which gave them little fighting chance by the time of their eventual collapse this month. The banks shares lost over 75 per cent of their value over the last 12 months.
Should we be concerned?
There are a few concerning factors surrounding Credit Suisse’s collapse. It must be noted that, regardless of the banks overall reputation, Credit Suisse had healthy capital and liquidity ratios which was not enough to protect them once confidence disappeared. Further to this, Eurozone banks are not earning enough profit to cover cost of capital which is destroying shareholder value across the board. Finally, interest rates continue to rise, meaning the vale of banks’ holdings of government bonds, mortgages and other debt will continue to take significant hits.
The knock-on effect of Credit Suisse’s collapse has caused AT1 bonds across multiple European banks to tumble. As an example of the perceived cost of debt in the market, UBS’ AT1 bond, callable in January 2024, went from trading at a yield of 12 per cent to nearly 29 per cent. Rising bond yields are negative for bond holders due to their inverse relationship with prices. When yields rise, prices of current bonds fall.
Though this could mean higher returns for investors, rising bond yields reflect a lack of trust and confidence and could indicate poor economic strategy. Overall, higher yields mean higher borrowing costs for governments or banks and, as such, it becomes more expensive for distributors of bonds to service their debts.
‘Safe and sound’
Essentially, a pattern of major bank collapses during a period of prolonged instability is never a great sign. Collapsing banks will spook investors, leading to deposit withdrawals which have knock-on impacts on banks across the sector. As more and more investors lose faith in the state of European banks, bond yields will increase making it increasingly expensive for Europe’s banks to service their debts.
However, the UK banking system has been described as “well-capitalised and funded” by the Bank of England and remains “safe and sound.” Christine Lagarde, president of the European Central Bank, has also indicated that “the euro area banking sector is resilient, with strong capital and liquidity positions.”
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