Treasury Today Country Profiles in association with Citi
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July/August 2010

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How safe are Europe’s banks?

At the start of summer, the spread between what banks lend in euros at three months and overnight rates had risen considerably. Although nowhere near the levels of September 2008 when spreads hit 1.95%, the widening was a warning sign that all was not well in the banking sector. In response, the EU announced it would stress test and publish the results for around 100 European banks.

America of course had great success with the publication of its stress tests. Nineteen of the largest US banks underwent the tests to see if they had enough capital to survive a severe recession, with ten banks needing to raise $75 billion in capital. The EU and its regulators are following suit, with a stress test that includes the additional requirement of banks needing to withstand sovereign debt default.

Why Europe is not America

European banks are vulnerable in a different way to that of their American counterparts because they are heavily reliant on the wholesale markets for funding, whereas US banks mainly cover loans with retail deposits. Hence, when trust goes, so too does liquidity for these banks, causing a crisis like that experienced by Northern Rock.

Of course, Europe has the added weight of its sovereign debt problem. European lenders had $2.29 trillion at risk in Greece, Italy, Portugal and Spain at the end of last year, including loans to governments, according to the Bank for International Settlements. And herein lies the problem: who is going to back up the banks at risk from Greece, Portugal, Spain and Ireland’s potential debt problems? To alleviate fears that it will be impoverished countries having to bail out their stressed banks, the EU Commissioner announced that the backstop would be two European schemes worth up to €500 billion if necessary.

Risk scenarios

If markets believe that these stress tests are credible, then the best outcome is that market confidence is restored, and banks should then find it easier to raise money in the markets. If not – estimates suggest that up to 20 banks may face failure and require around $40 billion to shore up their capital – damaged confidence and a round of pretty much unaffordable bailouts are next. The worst case is a fully blown sovereign crisis.

No matter what the outcome – and you can probably bet that governments and the EU will jump in and shore up the system – companies are fatigued, and even fed up with the banking sector and its continuing problems that are impacting confidence and therefore ultimately corporate growth and profitability. Companies are actively seeking alternative finance and many treasurers we speak to have put ’lessening reliance’ on banks as one of their top agenda items. Who can blame them?

Cash management divisions may be the innocent and still profitable sectors of the banks, but they too are suffering as companies just want the insecurity within their banking relationships to go away. Treasurers want honesty, transparency and the ability to realistically monitor their risks. They want to run their business without worrying about their banks as a primary risk source. That’s not happening.