European Banks Growing Bigger ‘Sowing the Seeds’ of Next Crisis


Bloomberg | December 2, 2009 | 19:01 EST

European banks are emerging from the credit crisis bigger than before, posing more risk to their national economies. BNP Paribas SA, Barclays Plc and Banco Santander SA are among at least 353 European lenders that have increased in size since the beginning of 2007, according to data compiled by Bloomberg. Fifteen European banks now have assets larger than their home economies, compared with 10 lenders three years ago. While the European Union has grabbed headlines for breaking up bailed-out banks, regulators haven’t reined in firms that shunned state aid and are too big to fail. European bank assets have grown 25 percent since the start of 2007, compared with a 20 percent increase at U.S. lenders, Bloomberg data show.

“We are sowing the seeds for the next crisis,” said David Lascelles, senior fellow at the London-based Centre for the Study of Financial Innovation, a research group. “What we have been doing in the last two years is making banks much bigger. It really goes against the currents of the time.” Banks expanded their balance sheets during the credit bubble, borrowing cheap money in the wholesale market to fund loans and investments. Royal Bank of Scotland Group Plc’s assets ballooned 2,914 percent in the 10 years through 2008 as it made acquisitions, boosted trading and increased lending. Edinburgh- based RBS spent $140 billion on takeovers during the period, culminating in the purchase of ABN Amro Holding NV in 2007 that triggered the world’s biggest bank bailout.      

BNP Paribas

Paris-based BNP Paribas, the world’s biggest bank by assets, increased its balance sheet by 59 percent to 2.29 trillion euros ($3.5 trillion) since the beginning of 2007, an amount equal to 117 percent of France’s gross domestic product. Assets at London-based Barclays jumped 55 percent to 1.55 trillion pounds ($2.6 trillion), or 108 percent of U.K. GDP. Santander’s rose 30 percent to 1.08 trillion euros, about the size of Spain’s GDP.

RBS has pledged to reduce its balance sheet by 40 percent over the next five years, and the European Commission, the executive arm of the EU, has ordered banks including Commerzbank AG, ING Groep NV and Lloyds Banking Group Plc, to sell assets as a condition of approving state aid. The EU doesn’t have authority over banks that weren’t bailed out, many of which continued to expand as European economies contracted. Banks such as BNP Paribas and Santander have taken advantage of their rivals’ woes to make acquisitions. Thirty-eight of Europe’s 100 biggest financial institutions have more assets now than they did at the beginning of the year, according to Bloomberg data.

Exposing Weakness

Deutsche Bank AG, Banco Bilbao Vizcaya Argentaria SA and UniCredit SpA, all of which expanded over the past three years, have below average risk-adjusted capital ratios, a measure of their ability to withstand losses, according to a Nov. 23 report by Standard & Poor’s. More weak banks may be exposed as the European Central Bank withdraws cheap loans that propped up the financial industry last year. Commerzbank, based in Frankfurt, and Dexia SA fell as much as 4.4 percent on Nov. 20 after central bank President Jean-Claude Trichet explained the need to slow the flow of cash. The credit crisis shows that large institutions pose too great a risk to their home countries, especially in Europe’s relatively small economies, said Tom Kirchmaier, a fellow at the London School of Economics, who lectures on finance and corporate governance. “Breaking up banks that are too big to fail has, in my view, a lot of merit,” Kirchmaier said. “If we were to have another systemic shock and one or more of these very large banks would fail, I have serious concerns whether some of the smaller countries would be in a position to absorb the losses for a second time.”

U.K. Bailouts

Britain, with an economy one-fifth the size of the U.S.’s, faces widening budget deficits, rising unemployment and increased taxes after four bank bailouts, including the 45.5 billion-pound rescue of RBS. The damage was even greater in Iceland, which had to seek emergency assistance from the International Monetary Fund after the country’s banking system collapsed. The island is now struggling to recover from the deepest recession among the world’s advanced economies, according to the IMF, after the stock market plunged 98 percent. European governments overall have provided $5.3 trillion of aid to banks in the past two years. Bailed-out banks are the nine worst performers in the 64- member Bloomberg European Banks Index since Lehman Brothers Holdings Inc. filed for bankruptcy on Sept. 15, 2008. RBS plunged 85 percent for the biggest decline. Lloyds dropped 63 percent, Commerzbank 58 percent and Dexia 43 percent, compared with the 18 percent decline in the index.

Growing Complexity

The increasing complexity of banks makes it difficult for regulators and governments to monitor risks, even at firms that appear transparent and stable, said Johannes Wassenberg, managing director of European banking at Moody’s Investors Services in London. “UBS was understood to have very good management, but that failed dramatically,” Wassenberg said. “The market is placing an enormous amount of faith in banks to regulate themselves, and it is hard to know whether they’re doing it properly. From that perspective, smaller banks are a safer bet.” Zurich-based UBS AG has reported 57.5 billion Swiss francs ($57.8 billion) of losses and writedowns since the credit crisis began, the most in Europe, and received a 6 billion-franc bailout from the Swiss government. The bank has reduced its assets by 37 percent since the start of 2007.

Too Simplistic

It’s too simplistic to attack all large banks, said Ralph Silva, research director at Tower Group Plc in London, which provides research on the financial services industry. “Banks have different business models,” Silva said. “Some of the bigger banks actually have better risk management than some of the smaller ones.” Leaders of the Group of 20 countries, including France, Germany, Italy and the U.K., agreed in September to develop by the end of 2010 rules that will make banks hold more and better- quality capital and discourage the use of leverage.

In addition, regulators and government officials across Europe have proposed solutions including forcing banks to separate retail operations from riskier investment banking and requiring lenders to write so-called living wills that would outline how they would be broken up in the event of a collapse. “Banks increased both the size and leverage of their balance sheets to levels that threatened the stability of the system as a whole,” Bank of England Governor Mervyn King said in an Oct. 20 speech in Edinburgh. “If our response to the crisis focuses only on the symptoms, rather than the underlying causes of the crisis, then we shall bequeath to future generations a serious risk of another crisis even worse than the one we have experienced.”

U.S. Proposal

In the U.S. Congress, the House Financial Services Committee is considering a measure giving the government authority to break up healthy, well-capitalized firms whose size threatens the economy. The legislation, opposed by the financial industry and Republican congressmen, must be approved by the full House of Representatives and the Senate and signed by the president to become law. The five biggest U.S. lenders — Bank of America Corp., JPMorgan Chase & Co., Citigroup Inc., Wells Fargo & Co. and Goldman Sachs Group Inc. — held $8.3 trillion in assets as of Sept. 30, an amount equal to about 60 percent of GDP and more than three times the $2.5 trillion in assets held by the top five financial companies in 1999.

‘Risk, Not Size’

In the U.K., the five largest banks — HSBC Holdings Plc, Barclays, RBS, Lloyds and Standard Chartered Plc — have 6.1 trillion pounds of assets, or about four times GDP. A decade ago, the top five banks had 1.2 trillion pounds in assets. European banks report assets under International Financial Reporting Standards, which require them to list the value of all derivatives. U.S. Generally, Accepted Accounting Principles allow lenders to report the net value of such securities. Europe’s bank bosses have gone on the offensive in recent weeks to head off stricter regulation, arguing that the quality of a lender’s assets, not the size of its balance sheet, determines the threat to the economy. Deutsche Bank Chief Executive Officer Josef Ackermann said Nov. 16 that indiscriminately breaking up banks will slow economic growth because large institutions are needed to finance development projects and large companies. “It’s the amount of risk, not size in itself, that justifies higher capital requirements,” Ackermann said at a conference in Frankfurt. “In a market economy, the size of a company per se shouldn’t be automatically deemed damaging.”

‘Adverse Consequences’

HSBC, based in London, was the top-rated bank in the S&P survey, with a risk-adjusted Tier 1 capital ratio of 9.2 percent at the end of June. Customer deposits totaled $1.16 trillion, compared with $925 billion of loans. Only 18 of Europe’s 100 biggest lenders by assets have more deposits than loans, reducing their reliance on wholesale financing. HSBC’s assets have grown 30 percent since the start of 2007. Santander CEO Emilio Botin says his company’s business model, with 85 percent of revenue coming from retail and commercial banking, helps control risk. Also, the capital of the bank’s international units remain independent of the parent and under the control of local regulators, reducing the risk of contagion, Botin said last month at a conference in London. “Limiting or penalizing the size of banks through greater regulatory capital requirements will not solve the problem,” Botin said. “It could even have adverse consequences, such as creating an unlevel playing field and harming financial flows toward the real economy.”

‘Pathetic’ Oversight

In contrast to Santander, Barclays increased its reliance on investment banking after it bought Lehman’s North American unit and hired bankers in Europe and Asia to expand the business. Barclays may get half of its profit from investment banking by 2011, according to Alex Potter, a London-based analyst at Friedman Billings Ramsey. Tony Lennon, president of the U.K.’s Broadcasting Entertainment Cinematograph & Theatre Union, is concerned that the drive for new international rules is slipping away as the recession comes to an end. The financial crisis was like a nuclear reactor on the verge of exploding, Lennon said. Now that the danger of Armageddon has passed, banks and regulators are continuing as if nothing happened, he said in an interview on Nov. 16 at a Trades Union Congress conference in London on the U.K. economy. “The reform so far has been pathetic,” Lennon said. “In the U.K., you had ATMs hours away from collapse. You need a complete overhaul of the system, and at the moment, I can’t see it coming.

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