Monday 21 January 2019

Italian bank job spoils ECB's birthday as new year sees same old problems

Eurozone banks' continuing issues have cast a long shadow over the single currency's 20th anniversary party

The then Taoiseach, Bertie Ahern, jokes about the new euro currency with Jim O’Neill and his wife Marian, of O’Neill’s newsagents, in January 2002. Photo: PA
The then Taoiseach, Bertie Ahern, jokes about the new euro currency with Jim O’Neill and his wife Marian, of O’Neill’s newsagents, in January 2002. Photo: PA

Dan White

Last week the euro celebrated its 20th anniversary. The single currency's birthday celebrations were overshadowed by the ECB's decision to effectively take control of Italian bank Carige, the first time it has used its powers in this way. The decision has once again highlighted the parlous condition of the eurozone's banks.

On Wednesday, the first working day of the new year, the ECB announced that it had appointed administrators to Banca Carige, Italy's 10th largest bank.

The ECB's move came after last month's rejection of a proposed €400m new share issue by Carige's existing shareholders who would have seen their stakes heavily diluted.

On their own the problems of a small regional Italian lender - with gross assets of just €24bn Carige is less than a fifth the size of Bank of Ireland and only just over a quarter that of AIB - should be a matter of no great significance.

However, the appointment of administrators to Carige is merely the latest indication of the deep underlying problems of the eurozone's banking system.

Elsewhere in Italy, after 20 years of little or no economic growth under the single currency, the country's banks are weighed down by an estimated €175bn of problem loans.

And it's not just the Italian banks. Germany's largest bank, Deutsche Bank, has seen its share price fall by more than 50pc over the past year. At last week's €7.13 share price, the whole of Deutsche is valued at just €14.6bn and is trading at the equivalent of less than a quarter of its book value.

Even the Irish banks, which operate in the fastest-growing economy in the eurozone and were bailed out by the Irish Government at a gross cost of €64bn, are under pressure with the share prices of both AIB and Bank of Ireland down by a third over the past year.

Despite operating in the midst of turbo-charged economic growth, all of the major Irish banks are struggling to grow their lending books with the most recent Central Bank figures showing that Irish bank lending to households and non-financial companies rose by less than 1pc in the year to October 2018 while lending to financial companies fell by more than 7pc over the same period.

Overall the Euro Stoxx index of the leading eurozone bank shares, which includes both AIB and Bank of Ireland, is down by almost a quarter over the past year and by a massive 82pc on its May 2007 peak.

So why, more than a decade after the financial crash and several years into an economic recovery, are the eurozone banks still in the doghouse?

At least part of the problem is the regulatory safeguards put into place following the 2008 financial crash.

The latest of these is Basel III, which comes into force in March. Under Basel III banks will have to hold capital reserves equivalent to up to 9.5pc of risk-weighted assets.

While more heavily-capitalised banks are less likely to get into trouble and have to be bailed out by governments, there is a downside.

"With Basel III the banks have had to continuously raise capital," says Thomas Conlon, associate professor of banking and finance at UCD.

While it is still early days, the Carige affair is already raising disturbing questions. Although the ECB has taken management control at Carige it could, and arguably should under its own regulations, have done much more.

By opting for the half-way house of appointing administrators to Carige, the ECB has sidestepped, at least for now, having to "bail-in" bond investors or depositors.

This is despite the Single Resolution Mechanism, the regulations governing the wind-down of insolvent eurozone banks that came into force three years ago, containing provision for depositors and bond investors to share the cost of bailing out bust banks.

In isolation imposing a bail-in at the relatively tiny Carige would be neither here nor there. But is the ECB balking at establishing a precedent that might be cited if larger, more systemically-important eurozone banks were to get into difficulties?

Coming just a month after we learned that the Anglo subordinated bondholders are to be repaid the €267m which they were owed in full, this reluctance to bail-in at Carige will have a certain grim irony for Irish taxpayers.

The continuing problems of the eurozone banks more than a decade on from the crash is clear evidence that there will be no going back to the pre-2008 "normal".

The world has moved on and the banks will have to move with it.

Technology is utterly changing the way in which banks do business. Unfortunately, most of them have been playing catch-up allowing what were previously thought of as technology, social media and telecommunications companies to invade traditional banking turf.

"These guys [the tech companies] can do better credit scoring. They know more about you. There is also the network effect of having billions of customers. That is something no bank can match", says Conlon.

Just to further hamstring banks, much of the information which they do hold on their customers - the existence of an online betting account has long been reputed to be a particular black mark against any customer applying for a mortgage - is now probably off-limits to them as a result of the EU's GDPR data protection regulations that came into force in May 2018.

To survive the eurozone banks will have to exploit both their remaining advantages, not least their reduced but still substantial ability to leverage their capital and change their business model. Having been left at the starting blocks by the nimbler tech companies, they are now going to have to spend heavily playing catch-up.

Not all of them will succeed. The Euro Stoxx bank index includes the shares of no fewer than 26 eurozone banks. As the eurozone moves in fits and starts towards a single banking system, that number is going to fall dramatically, possibly to as few as half a dozen and certainly to no more than 10.

This is what has happened in the United States where just five banks - JP Morgan Chase; Bank of America; Wells Fargo; CitiBank; US Bank - control almost half the assets of the US banking system. What are the odds on something similar happening in the eurozone?

If, or more likely when, this happens the winners will be those banks that spend heavily embracing technology.

This does not bode well for the Irish banks which, since the crash, have largely shed their overseas operations and reverted to being relatively small regional players.

"Scale is crucial. Banks will need to have an international scale and a willingness to spend," says Conlon.

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