In Europe, and especially in southern Europe, many banks suffer from the burden of bad loans. Most States, because of the Maastricht criteria of the European Treaties, have not been able to recapitalise their banks adequately. In many cases, recapitalisation would not have made sense either, because there are simply too many banks in the respective countries. In Europe, attempts have been made to keep as many institutions as possible alive and to transfer their bad investments into public ownership, i.e. to socialise their losses. The need for consolidation is huge and urgent.
I think that by the end of 2019 only 110 banking groups or independent banks will remain of the more than 500 institutions currently in existence.
The pressure in the system can also be seen in the share prices of the European banking sector. (see Chart 44)
The price/book value ratio of the bank shares on the stock exchange reveals the state of the banks. The price/book value ratio evaluates the banks' equity capital and indicates how much a buyer has to pay for one euro of equity capital. Valuations of less than 1 are a discount on the equity capital, in Chart 45 approximately 57 cents have to be paid for one euro of equity.
The market regards only half of the balance sheet equity as recoverable, the rest is valued as used. The depreciation requirement estimated by the market would consume almost half of the equity capital, with the result that the majority of banks would have to be closed and liquidated by the supervisory authorities.
An important function for measuring systemic risk is the SRISK function. It describes the need for recapitalisation to restore the normal capacity of banks to act in the event of a 40% collapse of the capital markets, a systemic crisis. The calculations of the team around Nobel Prize winner Robert Engle at New York University show that the risk for all US institutions is currently around 275 billion US dollars. Europe would have much greater problems in a crisis. The French banking sector alone would have to be recapitalised in a systemic crisis at around 300 billion US dollars. The capital requirements of the Italian sector are estimated at around 111 billion US dollars and those of the German banking sector at around 106 billion US dollars. Deutsche Bank and Commerzbank bear almost the entire risk of 76 billion US dollars and 25 billion US dollars respectively.
While Germany could certainly cope with a recapitalisation of its two major banks, France with 300 billion and Italy with its 132% national debt and a further 482 billion euros in debt in the Target-2 system, would probably be overburdened. It is very much in the interest of both countries to pass on their risks to other countries. The banking union would make this possible.
The European Banking Union has been largely negotiated. It is to be based on three pillars. (see Chart 46) The first pillar is the single supervisory authority for large banks operating in the Eurozone (SSM: Single Supervisory Mechanism). It is based at the ECB. The second pillar is the Single Resolution Mechanism (SRM) for bankrupt systemically important banks. These are to be settled by an independent authority called the Single Resolution Board (SRB). The SRB can rely on a fund that was set up in 2016 and will be fed by the European banks. At the end of the eight-year development phase, this fund will control 1% of the deposits covered by the insurance from approximately 3,500 European banks, which would be around 55 billion euros. This fund is called the Single Resolution Fund (SRF).
If these funds are not sufficient, the European Stability Mechanism (ESM), fed with taxpayers' money from the nation States, would step in according to the Commission's plans. However, this proposal has not yet been accepted in the Eurogroup. It was agreed that the ESM's funds would come only temporarily from tax revenues. According to Klaus Regling, who took part in the meeting, the funds used are to be balanced again within 2-3 years through payments by European banks. In a major crisis, this idea is completely unrealistic. Our feeling is that this proposal is immature. Apart from this point, these first two pillars have probably already been finally negotiated and should be implemented quickly.
Risks that have arisen under national responsibility, should not be subsequently mutualised.
Incidentally, Macron's and the Commission's ideas originally went far beyond the current state of play. The ESM was set up in October 2012 in order to provide the crisis States with financing. It was set up with a share capital of €705 billion, of which €81 billion was paid in directly and €624 billion obtained through calls to the Member States. When the IMF became less and less willing in the following years to provide money for the rescue of Greece, the idea was even touted of having the tasks of the IMF in the Troika taken over by a European Monetary Fund. It was probably Wolfgang Schäuble's idea that the ESM should be given the task of monitoring compliance with the European rules. The idea of the European Monetary Fund was therefore gladly taken up. In the meantime, however, the concept has been significantly changed by the European Commission. It would like to use the ESM for political goals. At the beginning of November 2018, the German Federal Audit Office therefore published a study that clearly warns of the risks. For example, the Audit Office warns that ESM funds could be used to communitarise the liability of the risks of the European banking sector. Losses would become more likely and . capital increases might become necessary. Everything points to the funds being used as transfer payments and being perceived as such. At present, this proposal does not seem realistic If the Federal Audit Office expresses itself publicly but so clearly and critically, it must have been discussed internally in 2018.
The third pillar is to be the joint deposit insurance known as EDIS. EDIS is a political hot potato. The politically well-networked German Volksbanken and Sparkassen in particular are against this proposal. They fear that the money they have accumulated will be used in southern Europe. Now that the negotiations have come to a standstill, a new group of experts is to be appointed to present their report or proposal in June 2019, after the European elections. There are considerable problems lurking in this banking union. We would like to point out four:
The monies from the SRF would probably be used in the south. The biggest problems lurk in the Greek, Italian and French bank balance sheets. Northern European banks are also in a bad position, but most of the money would probably be spent in southern Europe. At the end of the day, northern European bank customers would cover the problems of the south via higher fees.
As already mentioned, the 55 billion of the SRF might not be enough. According to the ECB, European banks will probably continue to hold over 759 billion in bad loans from 2018 onwards. Many risks are likely to be hidden. If the ESM has to intervene, taxpayers' money will migrate from northern to southern Europe. The sums could be colossal. Whether the funds invested could be reimbursed by the banking sector is very questionable given the large potential defaults.
The introduction of the European Deposit Insurance System (EDIS) is intended to transfer national deposit insurance schemes to the European level. This process is set to be rolled out in phases and completed by 2024. It remains to be seen whether the German government will agree to this timetable.DIS is particularly problematic because, in individual countries such as Italy or Greece, for example, huge amounts of bad loans are on banks' balance sheets and bankruptcies can occur at any time. Although the Federal Government only wants to agree to EDIS if the bad loans have been sufficiently reduced, unfortunately we cannot trust the official data supplied by the authorities. The bank auditors, for example, did not see the bankruptcies of several Italian banks coming in 2017.
The new Single Supervisory Mechanism (SSM) will be headed in future by the Italian Andrea Enria, who has prevailed against his competitors following massive lobbying by the chairman of the Economic Committee of the European Parliament, the Italian Roberto Gualtieri. Gualtieri had portrayed the renowned governor of the Irish central bank, Sharon Donnery, as a quota woman. Enria has in the past advocated more joint liability in the eurozone.
A Frenchman could succeed Italian Draghi as ECB chief. In view of the major problems, especially with Italian banks, it remains unclear whether the rules will be complied with in future. In recent years, the EU has simply ignored its own newly created set of rules with almost each successive bank failure.
Currently, there is still a lawsuit pending before the German Federal Constitutional Court against the banking union. The oral hearing took place on 27 November 2018. The ruling is due in a few months.
List of references for the used photos and charts: