They could collapse at any moment. They had insufficient capital to finance businesses, and their profits were so weak they were a drag on all the major indices. For over a decade, ever since the euro-zone crisis of 2011 and 2012, Europe’s major banks, including those in the UK, have been by far the weakest part of the economy. However, there has been a clear recovery over the last year, with banking stocks among the best performers and a genuine profit improvement. There is just one catch: It will not last—there are still too many risks out there.
It has certainly been the best year for a while for anyone with money invested in European banks. MSCI Europe Banks Index is up by 35% compared to 14% for the market as a whole. It has hit its highest level in six years. In London, Barclays is up by 18% and HSBC by 13%. There are a few stand-out performers within that. UBS is up by 46%, Deutsche Bank is up by 48%, while the two major Italian banks, UniCredit and Intesa Sanpaolo, have reached 13-year and nine-year highs, respectively.
Re-wind a little more than a year, and the London branch of Silicon Valley Bank had to be bailed out, Credit Suisse had to be hustled into a shot-gun merger with UBS, and there were constant rumours that one of the major German lenders—perhaps even the once mighty Deutsche Bank—might have to be bailed out. It is quite a turnaround.
It is not hard to work out what is behind the recovery. Higher interest rates have boosted margins, allowing the major banks to put their balance sheets back in order. Economies across Europe are not exactly on fire, but they are at least stable. Meanwhile, in countries such as Italy, which had been in recession for years, there are signs of a genuine recovery. Put all that together, and the banks can make some money for the first time in a decade or more.
The outlook is improving constantly, and that matters. Finance is one of the economy’s largest sectors, and, more importantly, just about every other type of business depends on a vibrant banking industry to provide credit and invest in new plants, machinery, and products. Without a healthy banking industry, economic growth is very hard to achieve.
The trouble is the revival can’t last. In reality, there are still too many challenges out there. To start with, there is still the potential for significant losses. The banking industry has survived the rapid rise in interest rates over the last two years with very little damage so far. That is a measure of how conservatively it has been managed in recent years, with minimal risky lending. However, there are two potential problems. As always, there has been a lot of lending to property developers, especially in commercial real estate. Office prices are plummeting due to the declining numbers of individuals working in offices five days a week, while retail space faces similar vulnerability as chains close and the internet takes a bigger chunk of the market. Just as seriously, the private equity houses look to have badly over-extended themselves when interest rates were close to zero and will now be left with lots of failing businesses. In either sector, there is still the potential for huge losses for the banks, especially if rates stay higher for longer than expected.
Next, Europe is drowning in government debt. In Italy, the state is still borrowing 7% of GDP this year, France more than 5%, and the UK more than 4%. Debt to GDP ratios is still soaring, and there is very little sign the books will ever be balanced. If there is a collapse in confidence in government debt, as there was in the UK during the short-lived Truss government, the banks will face huge losses. Finally, the tech-based challenger banks are still expanding all the time. Artificial intelligence (AI) applications may soon begin to take real market share away from established banks, and once that happens, their lock on the market will be under real threat. Once an industry goes into decline, it is very hard to reverse that.
True, Europe’s banking industry looks more stable than it has done for years. Balance sheets are in far better shape than they have been for more than a decade and are in a position to support businesses and the economy again. But no one should kid themselves that the recovery can last. Big challenges are still ahead—and another banking crisis could start anytime.
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