While all attention is being focused on China’s growing indebtedness and its ability to stave off a debt crisis, another series of bank failures could be in the coming in Europe. The cause of any possible debt crisis in China and any impending bank failures in Europe is at the core the same: slowing and weak economies. Return on lending by banks, given the monetary policy environment, is low and financial institutions are finding it difficult to remain profitable especially in the regulatory environment in the aftermath of the 2007-2008 financial crisis.
China, because of its political system that permits significant state intervention, can make nimble decisions to shutter some unprofitable state run enterprises, consolidate others and capitalize banks which have lent to the unprofitable state run enterprises to prevent any serious crisis from taking hold. Besides, Chinese financial institutions, as of yet, are not globally systemically important. This, however, is not true of European banks.
In Europe, both German in the north, despite expectations to the contrary, and Italian banks in the south are not faring well either with regulators or with investors. Deutsche Bank’s minimum capital ratio versus regulator requirement is severely short. The International Monetary Fund (IMF) has released a report saying that Deutsche Bank “appears to be the most important net contributor to systemic risks in the global banking system” as can be seen from the picture below.
The bank has been fined USD 14 billion by the United States Department of Justice for mis-selling mortgage-backed securities and at the current share price Deutsche Bank is barely worth more than the fine. Deutsche Bank hopes that the fine can be negotiated down to smaller number giving it breathing room to implement its restructuring strategy for 2020. Information is circulating that the German government, despite Deutsche Bank being its only major global player, does not intend to come to its rescue. The bank has said that it would not be needing a government bailout nor should it get one. Deutsche Bank should be allowed to fail if it comes to that in an orderly manner by the regulators by putting up its assets for sale to be acquired by other companies in the global banking industry and by saving its depositors.
Recent stress tests – designed to show how banks would weather a severe economic crash – highlighted weaknesses in Italy’s financial firms UniCredit and Monte dei Paschi di Siena (MPS). Italian banks are burdened by non-performing loans and as a result they are not intent on lending more which is holding back the economy. Italian economy has ground to a halt with zero growth reported in the second quarter of 2016.
The vicious cycle of a slowing economy and poor bank performance is plaguing Europe. It is important for the markets to keep an eye on European banks under stress, German and Italian in particular, for any signs of a cascade of bank failures which, if mishandled, can be to the detriment of the global financial markets and the global economy at this sensitive stage in the global economic recovery. Acquisitions by other global banks of underperforming European banks are a better way to go than government bailouts.
No financial institution should be “too big to fail.”