Risk in European Banking Phil Molyneux, Bangor University
Content • • • •
Structural change Bank Performance Bank Risk Regulation
STRUCTURAL CHANGE AND FINANCIAL INTEGRATION
Structural Trends •Decline in number of banks • Most marked in Germany
Structural Trends
•Mixed picture on industry concentration • 5‐bank asset concentration illustrates increases for Germany, Italy and the UK
Bank M&A in Euro area
Return on Equity (ROE)
• Collapse of Ireland bank profits in 2009 •Impact of banking crisis illustrated in 2008 and 2009 ROE figures
Financial Integration • Recent research suggests financial integration has led to a convergence in bank performance (Goddard et al, forthcoming, EFM) • However, since onset of crisis: – Value and number of cross‐border mergers has declined – Share of assets held by foreign branches and subsidiaries has slowly recovered toward pre‐crisis levels – Dispersion in interest rates on loans (particularly to non‐ financials) has increased since the crisis
Bank Performance
Performance of Large and Complex Banking Groups in the Euro Area Year
Return on Equity (%) Impaired Loans/ Total Assets (%)
Cost-Income Ratio
Tier 1 Ratio
Solvency Ratio
(%)
(%)
(%)
Median
Average
Median
Average
Median
Average
Median
Average
Median
Average
2005
10.04
11.93
0.08
0.11
60.69
58.87
7.89
8.2
11.05
11.23
2006
14.81
14.61
0.07
0.11
5595
56.4
7.75
8.07
11.01
11.16
2007
11.97
11.65
0.05
0.1
63
62.95
7.4
7.72
10.6
10.72
2008
2.26
-14.65
0.27
0.31
73.36
160.96
8.59
8.58
11.7
11.37
2009
2.97
0.34
0.45
0.55
60.35
62.47
10.15
10.33
13.6
13.37
2010
7.68
6.76
0.24
0.32
60.4
62.01
11.2
11.38
14.1
14.38
European bank write downs and capital raised until December 2010 (Top 20 Banks)
• Total write downs and losses by European banks up to December 2010 amounted to $550.5 billion •New capital raised equalled $485 billion
Figures from Bloomberg
Write down and losses $bn
Capital $bn
UK
75.9
97.8
UBS AG
Switzerlan d
58.4
51.1
3
HSBC Holdings Plc
UK
56
28.8
4
Barclays Plc
UK
44.8
31.6
5
Banco Santander SA
Spain
30.2
29.4
6
HBOS Plc
UK
29.5
25.7
7
UniCredit SpA
Italy
27.9
15.9
8
Credit Suisse Group AG
Switzerlan d
27.4
22.3
9
Deutsche Bank AG
Germany
24.5
28.9
10
BNP Paribas
France
24
13.6
11
ING Groep N.V.
Netherlan ds
19.8
24.6
12
Societe Generale
France
19.5
17.8
13
Bayerische Landesbank
Germany
19.3
21.4
14
Commerzbank AG
Germany
17.1
26.3
15
KBC Groep NV
Belgium
15
7.9
16
IKB Deutsche Industriebank AG
Germany
14.8
11
17
Allied Irish Banks Plc
Ireland
13
18
18
Banco Bilbao Vizcaya Argentaria
Spain
12.7
0
19
Danske Bank A/S
Denmark
10.8
0
20
Credit Agricole S.A.
France
9.9
12.9
550.5
485
Rank
Name
Country
1
Royal Bank of Scotland Group Plc
2
TOTAL
Tier 1 Capital & Shortfall
Bank Risks
Default of a euro area LCBG The median cost of protection against the default of a euro area LCBG, as reflected by CDS spreads, had increased signifigcantly by late November 2011 Substantially higher than in the aftermath of the collapse of Lehman Brothers in mid‐September 2008 increased hedging of counterparty credit exposures to euro area LCBGs has also contributed to higher CDS spreads.
Probability of Default of Big Banks
Bank Ratings
The rise of “systemically important financial institutions” (SIFIs) • Emergence of SIFIs is a development of crucial importance that greatly complicates financial regulation. • The rise of SIFIs reflects: – The rapid rise in financial integration driven by innovation, market reforms and increased financial openness. The cross‐border claims between banks at end‐2009 reached US$5.9 trillion. – That fact that countries are increasingly intertwined internationally—especially among a small number of countries. – The consolidation of national financial markets—in most countries
The rise of “systemically important financial institutions” (SIFIs)
Top 30 SIFIs (Most in Europe)
Stress Tests • In cooperation with the European Systemic Risk Board (ESRB), the EBA conducted EU‐wide stress tests are in a bottom‐up fashion, using methodologies, scenarios and key assumptions developed by the EBA in cooperation with the ESRB, the European Central Bank (ECB) and the EU Commission. • In 2011 they tested 90 banks in 21 countries, covering 65% of banking assets and at least 50% of banking assets in each country. • Results show capital shortages across many banks
The results of the 2011 stress tests • http://www.eba.europa.eu/EU‐wide‐stress‐ testing/2011/2011‐EU‐wide‐stress‐test‐ results.aspx
Moody’s Survey of Stress Testing Attitudes across 42 banks in 10 countries
Bank Regulation
Regulation and SIFIs • The 2007‐2009 financial crisis made clear that: – The operational and financial interdependence among financial intermediaries can create strong spillovers across markets. – Complications in supervision, regulation, and resolution could arise because of the many different regulators (national and international) involved. – Crises impose high costs on global real economy such as economic recessions, and larger government budgets (reflecting the direct costs of financial support, lost tax revenue, increased budget deficits and public debt). – It can be difficult for governments to resolve large financial institutions without putting significant public resources at risk. – If SIFIs cannot fail, government support is inevitable and the problem of moral hazard is exacerbated.
Case Study of Regulatory Reform: The UK Vickers Commission • The Vickers report aimed to contain the “too big to fail” problem and limit the implicit subsidy to banks from the prospect of their being bailed out by the taxpayer in the event of difficultly. • The key recommendation is to “ringfence” retail deposits to protect them from risky bank behaviour. – To this end, banks would need to hold more capital against retail and small business deposits (10% of deposits in the form of equity and up to a further 10% in other “loss‐absorbing” instruments such as “bail‐in bonds” or cocos), and the asset counterparts to these deposits would be low‐risk (i.e., no derivatives, debt and equity underwriting, or securities, etc.).
• If the ringfencing recommendation is implemented, the UK banking system should be safer for retail depositors than most other national systems
Case Study of Regulatory Reform: The UK Vickers Commission • Banks operating in the UK have complained that ringfencing will increase their costs. This will happen because of the loss of cheap retail deposits for funding risky activities, and a reduction in the implicit subsidy. • Proposed reform falls short because banks will still be allowed to engage in very risky activities such as proprietary trading (which they can no longer do in the US), and that no limits have been placed on wholesale (short‐term) funding. • The former is true, but these activities are outside the ringfence; the latter is supposed to be dealt with by Basel III, which will specify a net funding ratio. • In addition, work is proceeding separately on global standards for large bank resolution (living wills) and the UK is one of the leaders in this area.
Other regulatory reforms in progress include: • Ongoing work in the Basel Committee to assess the conditions under which contingent capital could be included in minimum regulatory capital • The regulatory perimeter is being expanded with major jurisdictions (the EU and the USA are finalizing legislation that for the first time establishes formal oversight over the OTC derivatives markets and its major dealers, hedge funds and credit agencies). • To make systemically important institutions internalize the (social) costs associated with their potential bankruptcy, several countries are considering, or have introduced, a specific tax on financial institutions (Austria, France, Germany, Sweden, and the United Kingdom).
Resolution plans & Living Wills • Economists have argued that banks should be forced to develop resolution plans or “living wills” to prepare for the possibility of failure (Claessens et al., 2010).
Conclusion
Conclusion
References Claessens, S, R.J. Herring and D. Schoenmaker (2010) A Safer World Financial System: Improving the Resolution of Systemic Institutions, 12th Geneva Report on the World Economy, International Centre for Monetary and Banking Studies, Geneva, and CEPR. Demirguc‐Kunt, A. and Huizinga, H. (2010) Are Banks Too Big to Fail or Too Big to Save? International Evidence from Equity Prices and CDS Spreads, World Bank Discussion Paper. ECB (2011) Financial Stability Review, December. Frankfurt: ECB. Goddard, J., Liu, H., Molyneux, P. and Wilson, J.O.S. Do bank profits converge? European Financial Management Forthcoming. Molyneux, P. and Wilson, J.O.S. (2011) Economic Conditions and Risk Taking in European Banking', Papeles de Economia Española, 130, 1‐13.