Covid-19 is the Last Straw for Europe’s Broken Banking System

Woe betide Europe’s banks if there is a second wave of the coronavirus.

By Ambrose Evans Pritchard and cross-posted from The Daily Telegraph.

European banks were already in trouble before the pandemic. They never recovered fully from the double shock of the global financial crisis and the eurozone policy errors of 2010-15, and have been trading far below book value. Now they are in even deeper trouble.

The Stoxx 600 bank index has fallen by four fifths from its peak and is currently at levels first reached (synthetically) in September 1988. It has been nothing less than a death spiral.

Europe’s lenders are half as profitable as US rivals. They are battling negative interest rates and falling fees, and now face the prospect of mass insolvencies from Covid-19. The day of reckoning has been delayed by state credit guarantees and furlough support but these will start to expire over coming months.

The danger is a European credit crunch as lenders act preemptively to protect themselves and shore up capital buffers. Many are already itching to shut down credit lines for thousands of vulnerable firms, threatening to set off a vicious circle and a second phase of the downturn.

The European Central Bank’s lending survey found that a net 23pc of banks plan to tighten loan conditions this quarter, akin to the incipient squeeze in late 2007 – which then tipped Germany and Italy into recession, months before the Lehman crisis.

A report by consultants Oliver Wyman estimates that credit losses for European banks could reach €830bn over the next three years in its “adverse scenario”.

The central case would see €400bn of losses. Even this would push non-performing loans to 10pc, rising to 12pc in Portugal, 13pc in Italy, and 47pc in Greece.

So far lenders have taken a hit of just €30bn in loan loss provisions. It said up to half of the European banking system will emerge from the pandemic “in a kind of limbo”, just keeping its head above water.

Lenders do not generate enough from retained earnings to rebuild their defences and will therefore be vulnerable to capital hits. They will instead have to cut their balance sheets by 10-15pc, choking credit for the real economy. A tenth of the banks will be walking dead

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