Special report | Sheep and goats

American banks have recovered well; many European ones much less so

Most European banks were slow off the mark after the crisis

“THE SHORT ANSWER is Hank Paulson,” snorts a European banker. “They got TARPed.” The question had been why America’s banks recovered so much faster than Europe’s from the debacle of ten years ago. Within days of Lehman’s demise in 2008 Mr Paulson, then America’s treasury secretary, forced the banks, as well as AIG, a giant insurer, and other companies to take equity injections from the federal government, whether they needed and wanted them or not.

TARP, the Troubled Asset Relief Programme, at first earmarked around $700bn for companies in difficulty. That was later cut to $475bn, of which $245bn was pumped into banks. With interest and dividends, the banks eventually repaid $275bn, having replaced public money with private funding. In 2014 the government sold its last shares in a TARP bank: Ally Financial, formerly the financial wing of General Motors.

The recapitalisation of Europe’s banks has been as gradual as that of America’s was swift, and in dribs and drabs of tens of billions a year rather than in one big splurge (see chart). It is still continuing. So far this year Deutsche Bank and UniCredit, the biggest lenders in Germany and Italy respectively, have raised €21bn in new equity.

European banks could have done a lot more sooner. Hyun Song Shin, of the Bank for International Settlements, calculates that between 2007 and 2015, 90 euro-zone banks retained €348bn of their earnings and paid €223bn in dividends. Had they kept the lot, they would have been able to stuff 64% more into their equity cushions. Because stronger banks tend to lend more, Mr Shin adds, profits, earnings and capital would have been that much higher if they had done so.

Nicolas Véron, of Bruegel, a Brussels think-tank, and the Peterson Institute for International Economics in Washington, DC, contrasts Mr Paulson’s “tough love” favourably with the reaction to the financial crisis of national supervisors in Europe. Authorities in the euro area were too concerned with protecting national champions from embarrassment, he says, “a story very much of forbearance and denial”. British and Swiss regulators were quicker than their counterparts in the euro zone, bailing out Lloyds, Northern Rock, RBS and UBS, even if British taxpayers paid a “scandalously high price” to save RBS.

Stress tests by European authorities were sometimes way off the mark. For example, they gave Ireland’s banking system a clean bill of health in 2010, just before it collapsed, and in 2011 allowed Dexia, a Franco-Belgian bank, to pass with flying colours just a few months before it was caught by exposure to Greek sovereign debt and bailed out by the governments of Belgium, France and Luxembourg.

The authorities eventually got their act together. Spain’s banking system, for instance, is much the stronger for a consolidation eventually co-ordinated by the state, although weak spots remain. Several cajas (local savings banks) clobbered by the country’s property bust were folded into more robust institutions. A grand total of 55 banks has been reduced to 14. Several leading lenders—Santander, BBVA, Caixa and Sabadell—have also expanded abroad.

Unlike America, the euro zone did have a second crisis to deal with, which posed a threat to its very survival; and it was only in response to the euro crisis that a common banking supervisor was created within the European Central Bank. The Single Supervisory Mechanism (SSM) has been up and running for just two-and-a-half years. It directly supervises the euro area’s 126 most important banks (the biggest in the zone, plus those critical to national economies, big or small), a group that accounts for 80% of the area’s banking assets. Oversight of the remaining 3,200 lenders is delegated to national authorities.

A union of sorts

Europe’s “banking union”, of which the SSM is a central element, remains incomplete, partly because German politicians balk at a plan to insure deposits across the euro zone. Rules on banking supervision, moreover, are still inconsistently applied. “We need regulations, not directives,” says Danièle Nouy, the head of the SSM. (Her point is that European Union regulations are adopted automatically by member states, whereas directives require implementation by national parliaments.) The directive translating Basel 3 into EU law contained more than 160 national options. A single capital market is also still far off.

These days European supervisors’ most pressing problem is Italy. Bad debts that seemed manageable back in 2007 grew into a mountain, reaching €360bn (at gross value) by 2015 as Italy’s economy failed to grow, borrowers ran into trouble and banks and supervisors procrastinated. Jean-Pierre Mustier, the newish French boss of UniCredit, is knocking the biggest bank into shape, writing down bad debt by €8.1bn, selling assets and raising €13bn in equity. Intesa Sanpaolo, the next-biggest, has been in decent shape for some time. But the fourth-largest, Banca Monte dei Paschi di Siena, is pinned down by its bad debts and awaiting state aid for the third time within a few years. Banca Populare di Vicenza and Veneto Banca, two smaller banks that plan to merge, are also seeking a bail-out.

The SSM wants to be sure that the banks will at last be well capitalised. In December it told Monte dei Paschi that it would need €8.8bn, but has since deemed it solvent. However, bail-outs must be approved by the European Commission, which oversees recently tightened state-aid rules to discourage continuing calls on taxpayers.

The state-aid rules say that junior bondholders as well as shareholders should be “bailed in”—ie, wiped out—if a bank has to be rescued. But in Italy many retail customers bought bank bonds believing them to be as safe as deposits. The Italian authorities are desperate to find a way of compensating them that satisfies the commission. A bail-in at smaller banks in late 2015 caused political uproar and resulted in at least one suicide. Precedent suggests that a solution should be possible; holders of similar Spanish bank bonds were compensated for falling victim to “mis-selling”.

But European banks’ plight stems from more than just being slow to recapitalise and sort out bad loans. Some countries, notably Italy and Germany, have too many banks and branches for all of them to flourish. A long period of ultra-low interest rates has flattened margins. German banks, which rely on interest for three-quarters of their income, the highest proportion in any OECD country, have been squealing almost as loudly as savers. A paper recently published by the Bundesbank forecasts that, if rates remain constant, a mere 20% of lenders will earn their cost of capital (estimated at 8%) by 2020; last year 60% did.

Thomas Olsen of Bain, a firm of consultants, argues that before the crisis, and even for several years afterwards, banks everywhere “didn’t really have different strategies”. Tight regulation had traditionally limited their scope for experimentation, but in the helter-skelter years leading up to 2007-08 banks grew indiscriminately, spreading into as many countries and areas of business as they could. After the fall, “they didn’t have a strategy then, either: they were just firefighting.” As the dust settled, they had to decide what strategy to adopt and how to put it into effect—often by retreating from unprofitable markets and activities.

Too many European banks have been slow to dust themselves off. Some at least went into the crisis with robust business models—and therefore did not need a thorough shake-up. Santander, which had built retail and commercial banking businesses in a number of countries, from Chile to Britain, was well placed to withstand the storm, even though its homeland took a battering. It is the euro zone’s biggest bank by market value and has made money in every quarter since at least the late 1950s. Like many banks, it has had to turn to shareholders to boost capital, raising €7.5bn in January 2015. Its share price is just a shade below net book value. By European standards it is doing fine.

Contrast that with Deutsche Bank. This used to be a slightly staid institution, serving Germany’s biggest companies at home and abroad and looking after well-off retail customers; but long before the crisis it had ventured far from that model, choosing the buccaneering life of international investment banking and trading. By 2007 it was leveraged to the hilt, with equity amounting to only 2% of total liabilities, one-third of the ratio at Santander. The crisis dealt it a heavy blow.

Not quite über alles

Deutsche is the biggest bank in Europe’s biggest economy and has not needed state aid, but it has had to turn to shareholders three times in seven years, tapping them for a total of more than €20bn. Despite a rally since last September, its shares have beeen trading at only two-fifths of book value. This January it concluded a $7.2bn settlement with America’s Department of Justice (DOJ), which had accused it of mis-selling residential mortgage-backed securities in the wild pre-crisis days of 2005-07. (Some other European banks have yet to settle; American offenders have already paid hefty penalties.) The bill was less than feared: initially the DoJ had demanded $14bn, and only $3.1bn of the settlement has to be paid in cash.

Now this is out of the way, Deutsche may at last have arrived at an enduring strategy. In March John Cryan, its chief executive since 2015, decided to keep Postbank, a retail operation he had previously intended to sell, shoring up Deutsche’s deposit base in Germany. To boost its ratio of equity to risk-weighted assets, a key regulatory measure of resilience, Deutsche has instead raised another slug of equity, €8bn-worth, and is selling part of its asset-management division. It is also reorganising its investment bank and has said that in future it intends to concentrate on serving multinationals.

Credit Suisse also took its time, changing tack dramatically in 2015. Its then-new chief executive, Tidjane Thiam, an ex-insurer, tilted the business towards Asia, seeing newly rich Chinese as ideal clients for a Swiss bank. He also cut investment-banking jobs and proposed a partial sale of the Swiss domestic business. Investors were unconvinced. In April he ditched that sale and announced a share issue.

Some European countries, notably Italy and Germany, have too many banks and branches for all of them to flourish

Others caught out by the crisis were quicker to narrow their ambitions. One was UBS, which was bailed out by the Swiss government in 2008. Mr Cryan, then the bank’s chief financial officer, helped turn it around. In 2011 it decided to concentrate more on wealth management worldwide and on its Swiss universal bank, and to cut back on investment banking. That meant missing out on a good year for fixed-income businesses in 2016, but over time it should involve fewer downs as well as ups.

All in all, European banks have fallen behind their American counterparts. In investment banking, where they compete head-to-head, the gap is worryingly wide. Part of the reason is that the Americans’ domestic market recovered sooner and more strongly from the crisis. According to Dealogic, a research firm, America yielded 48% of global investment-banking revenue in 2016, up from 41% in 2007 (and only 34% in 2009, its weakest year). Asia’s share also grew, but Europe’s shrank to 22% in 2016 from 36% in 2007.

American banks were naturally best placed to take advantage of growth at home, where they rule the roost. Asian (mainly Japanese and Chinese) investment banks, plus Morgan Stanley, thanks to MUFG’s stake in the American firm, lead the way in their home region. But European firms have also lost ground to the Americans on their own continent. The Americans fill four of the first five slots in Dealogic’s European regional league table. Only Deutsche prevented a clean sweep, coming third.

Leading the field both at home and abroad, you might suppose that America’s big banks had little to complain about. Even so they are restive, insisting that they got over the crisis years ago but are still being held back by a thicket of regulation. Donald Trump said he would cut through it all. But how?

This article appeared in the Special report section of the print edition under the headline "Sheep and goats"

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