Fragile European banking may trigger the next global crisis

    Friday, 02 August 2019

    Eleven years after the global financial crisis, the European banking industry is once again preparing for tough days ahead.

    After Deutsche Bank announced a large-scale layoff plan not long ago, another large European bank might follow suit to do the same. Italy’s largest bank by asset size UniCredit is considering 10,000 job cuts, accounting for 10% of the bank’s total global workforce. This layoff makes up part of the business plan that UniCredit will announce at the end of this year. UniCredit will announce at least 9,000 layoffs, and almost all the employees getting retrenched will be Italians. The negotiations between UniCredit and the union will begin after the announcement of its business plan for 2020-2023 on December 3 this year. The negotiations between both parties may help to reduce the number of layoffs from the original figures.

    UniCredit is a European bank headquartered in Milan, with operations in 19 countries and having more than 28 million customers. It is also one of the largest banking groups in Europe. The core business of UniCredit is mainly distributed in the more well-off regions of Italy, Austria and southern Germany, as well as a large number of businesses in Central and Eastern Europe. With assets of EUR 91 billion, UniCredit has become the largest bank in the Eurozone, the third largest in Europe and the sixth largest in the world. However, its profitability is in decline. According to publicly-accessible information, UniCredit’s net profit for 2018 was EUR 3.892 billion, a decline of nearly 29% compared to a net profit of EUR 5.473 billion in 2017.

    The recent frequent layoffs could be a possible indication that the European banking industry has not fully recovered from the financial crisis. After the crisis, the United States adopted quantitative and accommodative monetary and fiscal policies as guarantees, and through legislation to strengthen supervision of the banking industry. At the same time, the government helped the banks through the crisis by using national capital injection. The period of de-leveraging the banking industry is relatively short, and the profitability of the U.S. banking industry therefore recovered within a shorter span of time.

    In Europe, there was a lack of a unified fiscal policy. It was only in November 2014 that the single regulatory mechanism for the banking sector in the euro zone was launched. The de-leverage of the European banking industry lacked sufficient policy support and assistance, hence slowing its process of deleveraging. Since the total loans of 27 banks in Europe account for a much higher proportion of non-financial debt than the United States, the impact on the economy in its de-leveraging process was much greater, which in turn affected its profitability.

    On a more general level, the poor performance of the European banking industry stemmed from the slow recovery of the European economy and the tightening of banking regulations. Data from the World Bank reveals that from 2010 to 2017, the world’s GDP increased from US$ 65.96 trillion to US$ 80.73 trillion, representing an increase of 22.39%. Among them, the U.S. GDP increased from US$ 14.96 trillion to US$ 19.39 trillion, an increase of 29.61%. However, the EU’s GDP only increased from US$ 16.98 trillion to US$ 17.28 trillion, a mere 1.76% increase and far less than that of the United States. The economic growth of the EU is not only significantly lower than the global average, but also significantly lower than the United States.

    The reason why European banking performance is closely related to its economy is because European banks, especially small and medium-sized banks, are not highly globalized, and their business is mainly located in Europe. Only a few larger banks, such as Deutsche Bank, have branches around the world that provide services to customers globally. As the global trade frictions intensify and the downward pressure on the economy increases, the profits of these large banks are being affected. Small and medium-sized banks whose businesses are mainly concentrated in Europe will see difficulty in achieving improvement.

    After the financial crisis, especially since the European debt crisis, the strength of regulation in Europe has been increasing. The European debt crisis has exposed two major problems of the European banking industry. Banks conducting higher-risk businesses and the general EU financial system were under-regulated. To resolve this, the EU on the one hand has increased the banking capital adequacy requirements, prohibiting large banks from engaging in proprietary trading, and curbing excessive speculation in the banking industry. On the other hand, it established a banking industry alliance to form a unified regulatory mechanism, clearing mechanism and deposit insurance system. However, EU member states have major differences in the relevant new banking regulations. The increase in capital adequacy ratio and the divestiture of risky assets have augmented the stability of the banking industry. At the same time, it also led to a decline in the income and profit of the banking industry.

    Kevin Dowd, a professor of finance and economics at Durham University, has previously analyzed that the large European banks have suffered setbacks in the United States, and also contraction of their business activities. However, a careful analysis will reveal that the main problem in the EU banking industry is happening in European soil. The European banking industry is facing a major repayment crisis, and this crisis has been brewing for a long time. The thorny issue facing the European banking industry is caused by none other than the EU itself.

    Due to quantitative easing policies and excessive tolerance policies, the existing problems have worsened. Dowd believes that the EU banking industry is currently moving in the direction towards a crisis, and the EU bank’s bad debt loaning solution will fail to work. In the end, there will be the scenario where the taxpayers will have to bailout the banking industry who will then become too big to fail.

    It is worth noting that both Deutsche Bank and UniCredit are regarded as banks with high importance in the global financial system. If these banks are having problems, they will inevitably hold a major impact over the European financial system. In particular, the European economy has not recovered from the crisis so far. With the global trade war resulting in economic slowdown, the European Central Bank has clearly stated that in order to support economic growth, it may further introduce easing policies and even cut interest rates further.

    Long-term negative interest rates have seriously affected the profitability of the European banking industry, and should the interest rates fall further, the impact on these banks will be even greater. As these banks get into trouble, they will also affect the lending behavior of enterprises, which will in turn drag down the growth of the entire European economy and thus turning these events into a vicious cycle. If this shock continues to expand, it may trigger a new round of global economic crisis.

    Final analysis conclusion: The recent frequent layoffs in the European banking industry have highlighted its vulnerability in the post-crisis era, and in the context of global trade war and economic slowdown, this vulnerability may eventually evolve into a trigger for a new global economic crisis.

    Chen Gong