Europe’s Banks next Global Worry

Europe's banking system is in far worse shape than the US system. The losses may be bigger, and their capital to meet those losses definitely is insufficient.

Europe's banks have been much more aggressive in funding emerging-market expansion than US or Japanese banks. Western European banks have lent $4.5 trillion to various emerging-market countries, businesses, and consumers. Many Eastern European businesses borrowed in low-interest-rate Euros. New homeowners in Estonia, Lithuania, Latvia, Poland, Ukraine, Russia, Hungary and the rest of Eastern Europe borrowed in Euros and Swiss francs, and as their local currencies have collapsed they now find they owe more on their homes and loans than they are worth.

"European banks are only restricted on the basis of risk-weighted assets”. Is reported. “European banks have ‘assets’ of about 330% of their country’s GDP, compared to US banking assets, which are about 50%. They have an accumulated  $700 billion in loans to Asian businesses, that have seen their exports trade collapsing by on average over 30%, and additionally $1.3 trillion in loans to Eastern European Countries, which are in very serious recession, many of those loans are likely to end in a fiasco.”

On average the European Banks make use of a thirty times leverage, that’s to say for every 1€ they lent 30€, which implicates if they lose 3.3% on their loans, all their capital is wiped out. Large banks in the U.S. were too big to fail and consequently bailed out with taxpayer dollars, but in Europe the situation is different.

Regulators in the UK allowed 20:1 leverage on a regular basis. It is now about 40:1. Assets of UK banks are about five times as large as UK GDP, compared with the US ratio to GDP of just twice.

To explain it simply: The UK has banking assets which are five times as large as the annual domestic output of the country. They also had a housing bubble. They have their own bailouts to deal with, which are massive and will potentially get much larger. But at least they have their own central bank and government that can try to fix the problems.

But in the Euro-zone it’s another story: The European Central Bank, as yet, is not allowed to step in, like the FED in the US, to saving individual banks. Moreover it is a great dilemma, how to save a Spanish bank and not an Austrian bank.

Austria's and Swedish banks have made large loans to Eastern Europe, in Euros and Swiss francs, and are going to have large losses, far more than 3%, which would wipe out their capital, while bank assets in Austria are 4 times GDP. This situation is similar for Italy, Spain, Greece, Sweden and Ireland. All these countries relatively small do have banks that are too big to be saved.

The immense credit problems stem of the Euro zone banks stem from the emerging markets and Spain's huge housing bubble, this together is causing a severe global and risk and is an open invitation for much worse to come.

To put the dynamics in perspective: US bank-assets are only twice US GDP, Switzerland and Ireland are over 7 times, the UK over 5, and the Euro zone as a whole at 4 times.

Euro-zone banks are already stumbling from losses from US subprime-related problems. On top of that they now have to deal with even deeper losses from their own lending portfolios. If the losses were just 5% of the portfolio, which is an optimistic assumption, it would be 20% of Euro-zone GDP. But each country is responsible for its own banks. While it is thought that Germany will be able to handle its own problems, the prediction for Sweden, Austria, Italy, Spain and others is far from optimistic. Italy, Portugal, Spain, Greece, and Ireland are already running a massive deficit, and don’t have central banks to monetize their debt. For example 5% loan losses in Ireland would be 40% of GDP.

The equivalent of about $5 trillion is required for the mentioned Euro-zone countries compared with $2 trillion for the U.S. Where does Europe find these 5 trillion dollars?

This European banking crisis now on the horizon has the potential to be more severe as the sub-prime loans have caused. The world depended on European banks for much of the lending that allowed for growth and development. Like their US counterparts European banks are going to reduce their loan portfolios, called deleveraging, which won’t be fun at all. The world is going to need to find $5 trillion to finance government debt issuance, while at the same time private business and consumer debt has to be funded too.

Europe is a big customer of the US and Asia. Their businesses are going to be hit hard by the lack of capital, which of course is bad for employment, new development, conquering recession, etc.