How much would European Banks be required to write off of their loans to European governments? That is presuming a bad (not worst case) scenario of a 70% write down of Greek, Portuguese and Irish debt and losses of 30% on Spanish and Italian debt. The recent stress tests of 90 European banks and an IMF analysis of the CDS market provide some ball park numbers. The estimate is of the order of EUR260bn: a large amount but not nearly as much as the EUR700bn written off by European banks in the aftermath of the 2008-09 global financial collapse.
A consoling thought is that aside from the failures of their sovereigns, banks in Europe have little other additional exposure to private borrowers that they might have to write off. They have done very little additional lending lately, quite unlike the run up to the global financial crisis when lending growth was robust at close to a 10% annual growth rate.
Equity investors have made their own severe judgments as to the losses European Banks will incur. The Stoxx Europe 600 banks index is down just over 25% since1 August. Société Générale, France’s second-largest listed bank, has lost half of its market value since the beginning of August. Shares in Crédit Agricole, France’s number 3 bank, have dropped 35% while those of BNP Paribas, the largest French bank, are down 32% over the same period. More important perhaps than the absolute fall in the value of their shares, is that the market value of some of these banks is much diminished. This suggests very poor prospects for these banks and very little capacity to raise additional capital from their much damaged shareholders. Since 1 August the market value of Soc Gen has fallen from EUR25bn to its current value of EUR11.79bn while BNP is now worth EUR32.4bn compared to EUR52.4bn on 1 August. As far as shareholders are concerned they have already had to write off very large amounts of capital in their banks.
The question then becomes whether or not the European governments have the will and even perhaps the financial capacity to do what presumably the market place would be unwilling to do, and that is to recapitalize their banks. The alternative is a permanently impaired banking system unable to make the essential contribution to credit availability and economic growth that banks make. And a word of sympathy for banks – that is their shareholders – is in order. You can blame the lending officers of the banks for supporting US mortgage backed credit. You can hardly blame them for lending to their own governments – indeed they are obliged by regulation to do so because they are treated as being the safest of assets.
It can be expected that should some formal Eurozone governments’ defaults be acknowledged of the grave order indicated above (a possible but by no means certain event) governments will have to replenish the capital of their banks. Furthermore the liquidity strains of these banks will continue to be fully satisfied by the ECB – as they have to date. It is this support that has prevented a further melt down in Spanish and Italian debt as well as support for the banks using such debt as collateral for ECB support.
The responses of the US Fed and the US Treasury to the banking and financial crisis has very clearly pointed the way forward for European governments and the ECB. The very effective responses of the Swedish and Norwegian governments to their own banking crisis of the early 1990s are perhaps even better examples of crisis management closer to home.
The share markets may be pricing in not merely a bad case scenario of significant write offs of European government debt. They appear to be pricing a worst case scenario in which European governments and the ECB stand by and watch the European banking and financial collapse. This is a development that would not only harm its banks irreparably but would damage as irreparably the capacity of European governments to raise debt, a notion too ghastly to even contemplate. European leadership and technical central banking skills are surely capable of avoiding the worst case and be able to deal with what is a bad case fully discounted in the market place.