Challenges for European Banks

<br /> Challenges for European Banks – Marc to Market<br />




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Concerns about the health of the European banking system tend to
focus on bad loans and profitability. 
In a speech this week, ECB’s Vice
President Constancio suggested that officials were looking at two other issues.
 
First, Constancio expressed
concerns about the “unconstrained” ability of banks to generate
credit by creatively using collateral.
  The
collateral is pledged by the borrower, but they continue to enjoy the
benefits of ownership. However, sometimes, the pledged collateral is used by
the lender for their own purposes. This is called rehypothecation. The owner of
the collateral is often compensated for
this use, but there is a fear that this poses systemic risk.  
Constancio also warned about
the re-use of collateral. 
 The same assets are pledged as collateral more than
once.  Both of these practices can spur extensive lending among financial
institutions.  The high levels of mistrust during the Great Financial
Crisis had deterred credit extension, but now the fear is from the other
direction.  
Second, and related,
Constancio warned against attempts on the part of some banks to exclude repos from the calculation of leverage ratios.
  Leverage ratios are one of the
broadest metrics of risk.  Excluding repos
weakens the standard and removes a check on the creation of liquidity.  
For financial institutions,
one of the pressing problems in the repo market is the shortage of high-quality collateral at key times like
quarter and year end and around particularly stressful events. 
Some institutions appear to post lower quality collateral
with the ECB and use the higher quality
collateral for private sector activities.  However, the stricter repo
rules and the ECB asset purchases and still not fully conducive securities
lending program frustrate banks.  
Reuters reports the industry’s International Capital Market Association is
lobbying regulators to ease their and own rules and for the ECB to make more
than of the 1.5 trillion of government bonds it hold easier for banks to
borrow. 

European banks stocks are
performing strongly here in 2017. 
 The bank shares in the Dow Jones
Stoxx 600 are up 10.7% year-to-date compared with a 9.2% gain in the index
itself.  The MSCI European bank index is up 11.4% so far this year.
 An index of Italian banks has rallied more than 20%.  In contrast,
US bank shares are significant laggards. The KBW bank index is
practically flat this year, and while the NYSE financials are up 3.5%, the
NASDAQ banks are off 3.5%.   We suspect the European outperformance has
gotten ahead of itself and technical readings are stretched, warning investors
to be wary of a reversal.   

Disclaimer


Challenges for European Banks
Challenges for European Banks

Reviewed by Marc Chandler
on

May 12, 2017


Rating: 5

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