Europe’s Dying Bank Model
The good news for Europe is that it will not reenact the dramatic collapse of Lehman Brothers, thanks to the ECB’s unlimited ability to provide liquidity. But European leaders have yet to recognize that old bank business models are obsolete, and that reliance on private-sector leverage for repairing banks' balance sheets is doomed to failure.
LONDON – The good news for Europe is that it will not reenact the dramatic collapse of Lehman Brothers. The European Central Bank’s unlimited ability to provide liquidity ensures that. But European leaders have yet to recognize that old bank business models are obsolete, and that reliance on private-sector leverage for balance-sheet repair of both sovereigns and banks is doomed to failure.
Two years into the crisis, the authorities have correctly identified four crucial problems – sovereign debt, bank capital, the risk of a Greek default, and deficient growth. But they have yet to agree on cause and effect. Understanding the obsolescence of most European banks’ business models is absolutely crucial to sorting that out.
In general, the eurozone has outsized banks (assets equivalent to 325% of GDP) that are highly leveraged (the 15 largest banks’ leverage is 28.9 times their equity capital). They are also dependent on large quantities of wholesale debt – totaling €4.9 trillion (27% of total eurozone loans), with €660 billion maturing in the next two years – to fund low-yielding assets. According to Barclays Capital, the 15 largest banks increased their returns on equity by 58% between 1998 and 2007, with 90% of the gain coming from higher leverage. Returns have since collapsed.
LONDON – The good news for Europe is that it will not reenact the dramatic collapse of Lehman Brothers. The European Central Bank’s unlimited ability to provide liquidity ensures that. But European leaders have yet to recognize that old bank business models are obsolete, and that reliance on private-sector leverage for balance-sheet repair of both sovereigns and banks is doomed to failure.
Two years into the crisis, the authorities have correctly identified four crucial problems – sovereign debt, bank capital, the risk of a Greek default, and deficient growth. But they have yet to agree on cause and effect. Understanding the obsolescence of most European banks’ business models is absolutely crucial to sorting that out.
In general, the eurozone has outsized banks (assets equivalent to 325% of GDP) that are highly leveraged (the 15 largest banks’ leverage is 28.9 times their equity capital). They are also dependent on large quantities of wholesale debt – totaling €4.9 trillion (27% of total eurozone loans), with €660 billion maturing in the next two years – to fund low-yielding assets. According to Barclays Capital, the 15 largest banks increased their returns on equity by 58% between 1998 and 2007, with 90% of the gain coming from higher leverage. Returns have since collapsed.