There's a bitter cocktail of concerns swirling around Europe's banks

Number 13
Credit: Alamy

European banks have been rocked back on their heels by a multi-punch combination rather than a single knockout blow.

Almost all are affected by a wide range of worries; the exact blend varies from bank to bank depending on the clients and markets to which they are exposed, their funding structure and their business model. Here are the 13 main ingredients in the cocktail of worries playing on the market’s mind:


1. An economic slowdown

The cooling of the Chinese economy, long the engine of global growth, is bad news for banks with big operations in emerging markets, large exposures to commodities (which had been riding high on Chinese expansion), or sit in the midst of big trade flows – witness the extent to which the cost of insuring Standard Chartered’s debt has ballooned in recent weeks.

And China’s slowdown has knock-on effects in Europe, especially among Germany exporters.


2. Dodgy loans

Soon after the financial crisis, US regulators forced their banks to confront past mistakes and write-down the value of dodgy loans. A similarly cathartic process has been conspicuous by its absence in Europe.

Deutsche Bank, for example, is currently valued at about 30pc of its book price. This demonstrates a fundamental disconnect between what the bank thinks its assets are worth and the market’s confidence in that assessment.


3. Central banks

The markets are growing concerned that central banks are running out of ammunition. Some trace the latest sell-off to the Bank of Japan’s decision to cut interest rates into negative territory. To say this didn’t have the desired stimulatory effect would be an understatement – the Nikkei has since fallen 11.6pc.

All eyes are on Janet Yellen at the Fed to calm markets - and decide whether or not to keep hiking US interest rates Credit: Susan Walsh/AP



4. Low interest rates

The actions of central banks are now actively hurting some lenders. It’s very hard for banks to make money when rates are low and even harder when they are negative as is now the case in some parts of Europe.

Lenders effectively have to pay to deposit funds with central banks. Few are passing these costs on to customers for fear of losing them to their rivals.


5. Capital cushions

Lots of hard and expensive work has been done by banks to plump up their capital cushions, which act as buffers when if they start losing money. But they have to be built up further to hit tougher European targets in 2019.

There are essentially three ways of doing this - by increasing profits (not likely), shrinking balance sheets (not easy) or by asking shareholders for more equity (not clever with share prices so low already). If banks look like missing those targets, regulators could well force them to stop paying dividends.

Standard Chartered's boss Bill Winters joined the bank last year and rapidly raised $5.1bn of capital in a rights issue to dispell doubts over its financial strength  


6. Bail-in regimes

Governments want to make sure that taxpayers are never again on the hook for bailing out the banks. Or, at the very least, not until bank creditors have suffered losses too. So a new investor hierarchy has been established which imposes losses on certain bank creditors depending on how much trouble a bank gets in.

This has been tested out during the Cypriot banking crisis in 2011, when even depositors (who are technically lending money to their bank) were hit. Some the senior bondholders of Portugal’s Banco Novo were “bailed in” last month.

Banco Novo was set up after the failure of Espirito Santo, and some investors were bailed in last month  Credit: AP


This has made bank investors more aware of where they sit in the hierarchy and led to a more realistic pricing of bank credit risk. This is highly necessary but also extremely discomforting.


7. CoCos

There is little doubt that some creditors recklessly lent money to banks before the last financial crisis in the (not mistaken) belief that governments would step in if anything went wrong. Contingent convertible bonds, which converted to equity if banks get into difficulties, are an attempt to remedy this so-called “moral hazard”.

Investors fear that Deutsche Bank, led by John Cryan (right), could struggle to pay the interest on its cocos if it suffers a few more financial shocks Credit: DANIEL ROLAND


The problem is that most people invest in either equities or bonds, so there aren’t many natural buyers of CoCos, which are neither fish nor fowl. This means they can lose value very quickly at the merest hint of stress.


8. Regulation

New rules have rendered many business lines unprofitable. But many banks have hung in there hoping that their rivals would give up and they would be able to take a larger slice of a shrinking pie. It was like a massive game of business model chicken. None of the European banks blinked for years; now they all are.


9. Restructuring

Those banks that have finally woken up, smelled the coffee and decided that they can’t be all things to all people are shutting down unprofitable units and restructuring themselves. Which is probably a good thing. But it is neither easy nor cheap.

Barclays announced another 1,200 job cuts last month as it restructures its Asian and global cash equities businesses  Credit: Alamy



10. Litigation costs

Banks are still getting fined for past misdemeanours. When will this end? No one knows.

Jailed Libor banker Tom Hayes has become the face of wrongdoing at banks, but the industry still faces a series of fines over past misdeeds   Credit: AP


11. Uncertain future

Banks have plotted their paths to profitability and fat capital cushions some years hence. But there’s many a slip ‘twixt the cup and the lip. A big global recession, or financial scandal, or mass exodus of bonusless staff, or any number of other things could derail their plans.


12. Self-fulfilling prophecies

Banking is based on confidence. They can tell people they are not facing liquidity issues until they are blue in the face. But if creditors are worried about a bank’s solvency, they’ll stop lending them money. Then, all of a sudden, the bank won’t be solvent anymore.


13. Contagion

Banks are interlinked because they lend to, and trade with, each other. Investors therefore worry that, if one bank goes down it could take others with it. The financial system resembles a giant web.

There is no better illustration of this than the fact that the additional tier 1 bonds of Nationwide, a boring old UK mutual, were trading above par before Christmas and are now only worth about 88p in the pound.

Fear spreads quickly.