Europe may have sidestepped its latest catastrophe, at least for the moment, by hammering out a euro 100-billion bailout plan for Spain’s failing banks over the weekend.
But the intervention will do little to address the problem that continues to plague the Continent’s increasingly vulnerable financial institutions. Namely: a longstanding addiction to the borrowed money that provides the day-to-day financing that they need to survive.
It is a weakness that afflicts many Euro zone banking systems — most notably that of Italy, whose fragile economy is even bigger than Spain’s and whose banks also rely heavily on borrowed money to get by.
In Spain’s case, the flight of foreign money for safer harbours, combined with a portfolio of real estate loans that has deteriorated along with the Spanish economy, led to the collapse of Bankia, the mortgage lender whose failure set off the country’s current banking fiasco.
Europe hopes that this latest bailout — money that will be distributed to Spain’s weakest banks via the government in the form of loans, adding to their long-term debt — can resolve the problem. But investors and analysts worry that highly indebted banks in other weak countries like Italy might face similar difficulties in the months ahead.
Last month, the ratings agency Moody’s downgraded the credit standing of 26 Italian banks, including two of the largest ones, Unicredit and Intesa Sanpaolo. Moody’s warned that Italy’s most recent economic slump was creating more failed loans and making it very difficult for banks to replenish their coffers through short-term borrowing.
Because they have suffered no epic real estate bust, Italian banks have long been seen as healthier than their bailed-out counterparts in Ireland and Spain. And bankers in Italy have been quick to argue that Italian banks should not be compared to those in Spain.
But as economic activity throughout the region comes to a near halt, especially in perpetually growth-challenged Italy, the worry is that bad loans and a possible flight of deposits from the country will be a new threat to banks that already are barely getting by on thin cushions of capital.
And Italian banks cannot avoid the stigma of their government’s own staggering debt load. Italy’s national debt is 120 per cent of its gross domestic product, second only to Greece among Euro zone countries by that dubious distinction.
Also hanging over European banks are the losses that would hit them if Greece were to leave the euro currency union, throwing most of their euro- denominated Greek loans into default. Banks in France and Germany would be hurt the most, as they have been longstanding lenders to Greece. In a recent analysis, Eric Dor, an expert on international finance at the Iéseg School of Management in Lille, France, calculates that French and German banks would be out euro 20 billion and euro 4.5 billion, respectively.
The French bank Crédit Agricole, for example, via its Greek subsidiary, has about euro 23 billion in Greek loans on its books. If Greece were to leave the euro, the losses could exceed euro 6 billion, analysts estimate.
Because it was the financial excesses of banks in Ireland, and now Spain, that eventually forced those countries to seek bailouts, finding a Europewide solution to overseeing financial institutions has become a pressing priority for the euro zone’s leadership. Otherwise, Europe will be able to address the weaknesses of member country banks only when the time comes to rescue them.
But as the president of the International Monetary Fund, Christine Lagarde, said in a speech in New York on Friday, there is little time to waste in this regard.
“European banks are at the epicenter of our current worries and naturally should be the priority for repair,” she said.
Lagarde, who from her earliest days at the fund has focused on banking problems in Europe, left little doubt about how the issue should be addressed. “Let me be clear,” she said in her speech. “The heart of European bank repair lies in Europe. That means more Europe, not less. Less Europe will be bad for the Continent and bad for the world. So, policy makers in Europe need to take further action now to put the monetary union on a sounder footing.”
At the root of the issue is a simple fact: Just like the countries in which they operate, most European banks are highly leveraged entities. They depend heavily on borrowed money to operate day to day, whether making loans or paying interest to depositors.
For decades, the loans that European banks have made to individuals, corporations and their own governments have far exceeded the deposits they have been able to collect — the money that typically serves as a bank’s main source of ready funds.
To plug this funding gap, which analysts estimate to be about euro 1.3 trillion currently, European banks have borrowed heavily from foreign banks and money market funds. That is why European banks have an average loan-to-deposit ratio exceeding 110 per cent — meaning that on any given day, they owe more money than they have on hand.
In Spain, this problem has been even more acute. Bankia, before it failed, had a loan-to-deposit ratio of 160 per cent, one of the highest levels in Europe. Even the strongest banks in the country, like Santander, the global banking giant, have a fairly risky ratio of 115 per cent, while big Italian banks like Unicredit rely on bulk borrowing to a similar or higher degree.
In the United States, the comparable figure is about 78 per cent, which means that the biggest American banks have a surplus of deposits and extra cash that they must put to work. (That can pose its own perils, as JPMorgan Chase recently demonstrated with its disastrous trading bets.)
Of late, Europe’s bank funding gap has been filled largely by the European Central Bank’s temporary programme of low-cost, three-year loans.
Italian and Spanish institutions were the most aggressive in lining up at this lending window, and they used much of the low-cost financing to buy their own government’s bonds. In the long run, that particular form of patriotism is likely to hurt those banks’ finances, if the value of the bonds continues to decline.
In a recent report on the Italian economy, analysts at Citigroup said they did not expect Italian banks to suffer a fate similar to that of their Spanish counterparts any time soon. But they did highlight disturbing trends in nonperforming loans in Italy, which have doubled since 2008.
And they warned that the Italian banks’ frantic buying of government bonds made them ever more vulnerable to the staggering debts of the government in Rome.
© 2012 The New York Times News Service