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European Banks in The Endgame
Kristi Rohtsalu
May 2013
Copyright © Kristi Rohtsalu 2013. All rights reserved.
The contents of this presentation are not intended as a recommendation to buy or sell any security.
Who is who in European banking?
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Regulators & authorities Banks
Central banks:
ECB, ESCB and the
Eurosystem
European System of Financial
Supervision:
European Banking Authority
(EBA) and national supervisory
authorities
European Systemic Risk Board
(ESRB) under the ECB
Top bank brands:
National banking associations
and European Banking
Federation
+9 more G-SIBs (global systemically
important banks)
Cautionary statement*
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Banking data and statistics are often not directly comparable.
* See Appendix for more info.
Apples and oranges may look similar but they are not the same.
This analogy often applies to banking stats.
European banks in international comparison
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EU-27 Euro area UK USA Japan
Size of economy
GDP (current prices, € trillion, 2011) 12.65 9.42 1.75 10.83 4.24
Population (million, 2011) 502.4 332.0 62.6 315.0 125.5
Banking
Number of banks 7 162 6 210 368 6 291 142
Total assets of banks (€ trillion) 35.9 30.4 8.1 9.8 8.3
Total bank assets, % of GDP 284% 323% 463% 90% 196%
Total assets of top 5 banks (€ trillion) 10.6 8.5 7.3 4.8 4.6
Concentration: top 5 banks’ assets as %
of total bank assets30% 28% 90% 49% 55%
Concentration: top 5 banks’ assets as %
of GDP84% 90% 417% 44% 108%
Source: European Banking Federation, International Comparison of Banking Sectors (available as of April 2013)
Consider & compare the highlighted figures:
EU & US: debt financing for households and enterprises
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In contrast to the U.S., Europe (still) has a bank-based model:
Data source: European Banking Federation, EU Banking Sector: Facts & Figures 2012
0%
20%
40%
60%
80%
100%
Europe US
Capital markets etc.
Banks
Figures in the EU represent a variety of financial systems (1/2)
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Banking systems in Europe differ by size and ownership:
Data source: ECB – Consolidated banking data (Q2 2012), and Eurostat (GDP for 2012)
0%
200%
400%
600%
800%
1000%
1200%
1400%
1600%
1800%B
E
DE
EE IE
GR
ES
FR IT
CY
LU
MT
NL
AT
PT SI
SK FI
EZ
BG
CZ
DK
LV LT
HU
PL
RO
SE
UK
Bank assets - foreign banks (% of GDP)
Bank assets - domestic banks (% of GDP)
Eurozone countries
Rest of EU-27
Eurozone total
Figures in the EU represent a variety of financial systems (2/2)
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In some EU countries, the share of ‘shadow banks’ in total banking
assets is bigger than in the others:
Data source: ECB – Flow of funds data (Q2 2012), and Eurostat (GDP for 2012)
Note: Due to lack of detailed data about shadow banking in Europe, a broad definition that includes all other financial institutions (excl. Eurosystem, banks, and insurance and pension funds) is used.
0% 20% 40% 60% 80% 100%
Luxembourg
Ireland
Netherlands
United Kingdom
Denmark
Belgium
Italy
Sweden
Cyprus
France
97% 96%
61% 58%
83%
25%
60%42%
204%
127% 123%
59%
179%
237%
174%
109% 105%91%
62%
26%
0%
50%
100%
150%
200%
250%
300%
Germany Italy SpainSwe-den
SwitzerlandFrance
Top 20 European banks by assets, Total assets (Q2 2012) / Home country's GDP (2012)Rank indicates bank's rank in the ranking "Top Banks in Europe 2012". Number in brackets indicates asset volume in billions of euros.
Sources: BanksDaily.com, Eurostat, interim reports of banks
United KingdomNetherlands
... And Too-Big-to-Save banks...
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In several countries, banks are bigger than the economy:
The problem
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There is too much debt.
All advanced economies are at or above the limit
where debt becomes a drag on economic
growth...
Debt overhang in eurozone (EZ), in UK and in US
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Data sources: BIS, ECB, Eurostat, Federal Reserve Bank of St. Louis
0%
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EZ Non-Financial Debt, % of GDP
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UK Non-Financial Debt, % of GDP
0%
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2011q
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2012q
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US Non-Financial Debt, % of GDP
Nothing has really improved, the debt has been transferred from one
sector to another:
The problem for bankers
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...
For each debtor there is a creditor.
A debtor’s problem is a creditor’s problem.
A debt crisis is also a credit crisis.
...
Banks’ return on equity (ROE) < cost of equity
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Average return on equity, and cost of equity (derived based on CAPM) for G-SIFIs
Source: IMF, Global Financial Stability Report: Old Risks, New Challenges (April 2013)
Red line (ROE) has been below the blue line (cost of equity) ever
since the start of the crisis in 2007:
What has to happen?
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For insight, we need to go to the edge of
economic and monetary theory...
Theoretical perspective: What has to happen?
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1. Money is debt, i.e. loan on the asset side and
deposit on the liability side of a bank’s balance
sheet.
2. For debt, borrowers have to pay interest which
has never been ‘created’ as deposit on the
liability side of a bank’s balance sheet.
3. As interests for old loans need to be paid from
new money, that is from new debt, the debt curve
is growing exponentially.
4. On the other hand, for each new dollar or euro in
debt, there is less and less economic output.
5. At a point, economic output is not enough to
support the level of debt; that’s where ‘the music
stops’.
6. Somehow we have to get back to the levels
where economic value created per dollar or euro
in debt supports the level of outstanding debts.
Unless there is a miraculous jump in the value created by the real economy,
part of the debt has to be either: a) inflated out, or b) written off:
We are around
here.
Money ‘created’ ($ or €)
De
bt
to b
e r
ep
aid
/ e
co
no
mic
va
lue
cre
ate
d (
in $
or
€)
Debt
Economic
output
0
If debt has to be reduced, you’d ask...
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... Who / which country or bank
..will be left without a chair next in the ‘game of
musical chairs’?
The question is not that easy to answer
because of the...
...‘Lethal embrace’ of banks and governments...
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Greece, ...
Ireland, ...
Governments can sink banks... ... And banks can sink
governments
... Re-inforced by rating agencies...
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– Moody’s, credit opinion on RBS Group (12 Mar 2013)
‘Over the medium-term downward pressure on the senior debt
and deposit ratings could also arise if UK, European and
international authorities made concrete progress in enabling
burden sharing with senior debt holders in the resolution of large,
complex banks...’
... With controversial statements like this (stresses added):
... And because of the...
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... Linkages between banking nationalities:
Source: BIS, CGFS Papers, No 43. The impact of sovereign credit risk on bank funding conditions (July 2011)
BE = Belgium
CH = Switzerland
DE = Germany
ES = Spain
FR = France
GB = United Kingdom
GR = Greece
IE = Ireland
IT = Italy
JP = Japan
NL = Netherlands
PT = Portugal
US = United States
Oth = other countries
Ranking of countries
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Based on...
1) Severity of the debt problem:
Debt burden of the non-financial sector (households
+ non-financial companies + public sector)
Debt concentrations
2) Capacity of the country’s financial system to absorb
losses:
Capitalisation / leverage of the banking system
Country ranking: severity of the debt problem
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Malta’s debt burden is the highest, followed by Spain and Belgium.
Data source: Kristi Rohtsalu, Europe’s Debt Hole and What It Means? (August 2012)
Debt overhang
At limit
Neutral
Public sector NF companies Households Total
1 Malta MT
2 Spain ES
3 Belgium BE
4 France FR
5 Sweden SE
6 Netherlands NL
7 Denmark DK
8 Luxembourg LU
9 Italy IT
10 United Kingdom UK
11 Finland FI
12 Austria AT
13 Germany DE
New economies
1 Slovenia SI
2 Latvia LV
3 Estonia EE
4 Lithuania LT
5 Slovakia SK
MT
ES
BEFR
SE
NL
DK
LU
IT
UK
FI
AT
DE
SI
LV
EE
LT
SK
0,0
5,0
10,0
15,0
20,0
25,0
30,0
0% 100% 200% 300% 400% 500%
Ba
nk
ing
sec
tor
leve
rag
e (
As
se
ts /
Eq
uit
y)
Non-financial debt (% of GDP)
Country ranking: debt problem & banking system’s leverage
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At the riskiest end, we find some of the countries generally perceived as
safest: Sweden, Netherlands, Denmark (besides Spain, Belgium, France
and Malta).
Data sources: ECB, Consolidated Banking Data (Q2 2012); Kristi Rohtsalu, Europe’s Debt Hole and What It
Means? (August 2012)
AT = Austria
BE = Belgium
DE = Germany
DK = Denmark
EE = Estonia
ES = Spain
FI = Finland
FR = France
IT = Italy
LT = Lithuania
LV = Latvia
LU = Luxemburg
MT = Malta
NL = Netherlands
SE = Sweden
SI = Slovenia
SK = Slovakia
UK = United Kingdom
Threshold for
debt becoming a
drag on growth.
Ranking of Europe-based large international banking groups
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Basis for ranking:
• Financial results (as at Q2 2011 and as at Q4 2012)
• Analyst conference calls
• Official sources such as: IMF, Global Financial Stability Report: Old Risks, New
Challenges (April 2013)
• News coverage
Key indicators considered:
• Business model: Loans / Total assets
• Funding structure: Loans / Deposits
• Capitalization / Solvency:
Risk-weighted assets (RWA) / Total assets
Capital, common equity tier 1 (CET1) / Total exposure
• Efficiency: Costs / Income
• Market valuation: Price-to-Book ratio
• Management opinion: Proposed dividend / Book value
Banks: What I saw in (the hot) summer of 2011
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See the article: http://blog.logicoffinance.com/2011/08/hey-europe-what-is-going-on-part-3.html
More or less, every bank has very little capital and a funding gap:
Advanced risk management contributed to bringing us here
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Basel II / Basel III formula for running a bank with very little
capital while displaying a solid regulatory capital ratio:
RWA
CCAR
CAR – capital adequacy ratio
C – capital, consists of: common equity (CET1), additional
tier 1 capital (preferred shares etc.), and tier 2 capital (sub-
ordinated loans etc.)
RWA – risk-weighted assets, consists of: credit risk RWA,
market risk RWA, and operational risk RWA
Where:
Capital ratios of large EU banks (averages)
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0%
2%
4%
6%
8%
10%
12%
14%
16%
Current Basel III CET 1 / Exposure
CET 1 / Exposure
Total Capital
Tier 1
CET1
While current average regulatory capital ratio for large EU banks is 14.7%, their common equity capital forms just 3% of their total exposure:
Data source: EBA, Basel III monitoring exercise. Results based on 30 June 2012 (March 2013)
What has happened with European G-SIBs since the hot summer
of 2011?
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Data sources: banks’ financial statements; own calculations
NB! These indicators provide only limited picture.
Not much as far as solvency is concerned:
Assets /
Home
country's
GDP
Loans /
Total
assets
RWA /
Total
assets
Core Tier
1 capital
ratio
Core Tier
1 / Total
assets
Assets /
Home
country's
GDP
Loans /
Total
assets
RWA /
Total
assets
Core Tier
1 capital
ratio
Core Tier
1 / Total
assets
DEUTSCHE BANK AG → DE 76% 21,3% 17,3% 10,2% 1,8% 76% 19,7% 16,6% 11,4% 1,9%
BANCO SANTANDER S.A. ↓ ES 115% 62,1% 47,1% 9,2% 4,3% 121% 54,9% 43,7% 10,3% 4,5%
BBVA ↓ ES 51% 60,9% 56,5% 9,0% 5,1% 61% 55,3% 51,6% 10,8% 5,6%
BNP PARIBAS → FR 103% 34,8% 30,9% 9,6% 3,0% 94% 33,1% 28,9% 11,8% 3,4%
CREDIT AGRICOLE → FR 78% 43,9% 28,5% 9,6% 2,7% 99% 36,6% 23,9% 11,4% 2,7%
SOCIETE GENERALE → FR 54% 32,5% 28,8% 9,3% 2,7% 62% 28,0% 25,9% 10,7% 2,8%
BPCE → FR 52% 53,1% 38,3% 8,5% 3,3% 57% 50,1% 33,2% 10,7% 3,6%
HSBC HOLDINGS plc → UK 105% 38,6% 35,2% 13,3% 4,7% 108% 37,1% 41,7% 12,3% 5,2%
RBS GROUP plc ↑ UK 102% 37,7% 30,0% 11,1% 3,3% 97% 38,1% 35,0% 10,3% 3,6%
BARCLAYS plc ↓ UK 100% 29,6% 26,5% 11,0% 2,9% 97% 28,6% 26,0% 10,9% 2,8%
UNICREDIT S.p.A ↓ IT 60% 61,1% 48,5% 9,1% 4,4% 59% 59,0% 46,1% 10,8% 5,0%
ING BANK NV ↑ NL 158% 57,4% 33,4% 9,4% 3,1% 139% 62,2% 33,3% 11,9% 4,0%
Nordea Bank AB (publ) ↓ SE 157% 56,0% 30,3% 11,0% 3,3% 166% 51,1% 24,8% 13,1% 3,2%
UBS ↑ CH 266% 21,4% 16,7% 16,1% 2,7% 212% 22,2% 15,3% 19,0% 2,9%
Credit Suisse → CH 208% 22,5% 20,9% 13,1% 2,7% 156% 26,2% 24,3% 15,5% 3,8%
BankHome
Country
Review in summer 2011 Review based on Q4 2012 data
How the financial collapse has been avoided so far?
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1. Central banks are providing commercial banks with cheap
money.
2. Banks can then use this cheap money to acquire risky assets
that earn higher returns than the cost of funding.
3. Via various often complex arrangements, central banks then
more or less assure that the risky assets will not lose in
value, or at least not too much.
4. Accounting rules enable banks to take losses from the so-
called legacy portfolios only gradually, so that losses can be
offset from the future (subsidized) returns.
The reality and what’s coming
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• National ring-fencing and prisoner’s dilemma
• Banks are fighting for life and death
• A number of the Europe-based G-SIBs are due to be
reduced to regional or local players and/or sold in parts
• A significant part of the financial system is still due to be
nationalized, but not feasible on country level
• Bank creditors are set to take losses
• Financial center countries need to reconsider their business
models, incl.
− Luxemburg, Malta, Liechtenstein and Switzerland in
addition to Ireland and Cyprus
• Not much is needed for things to go bad
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Thank you!
Kristi Rohtsalu
LinkedIn: http://www.linkedin.com/in/kristirohtsalu
Contact: [email protected]
Disclosures and disclaimers
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KRISTI ROHTSALU’S DISCLOSURE:
I’m not qualified to give any specific investment advice. I’m not a CFA Character holder (Chartered Financial Analyst), a CFP
(Certified Financial Planner), a ChFC (Chartered Financial Consultant), a CMT (Chartered Market Technician), or the holder of
any other title from the “alphabet soup” of finance professionals. I’m long in some of the stocks mentioned (RBS, UBS, CS) –
however, this is for other reasons than profiting from my investments.
DISCLAIMER:
It’s not an offering for any investment. It represents only the opinions of Kristi Rohtsalu. Any views expressed are provided for
information purposes only and should not be construed in any way as an offer, an endorsement, or inducement to invest and is not
in any way a testimony of, or associated with, Kristi Rohtsalu or Finlighter OÜ. Kristi Rohtsalu is the founder of Finlighter OÜ.
This report may contain information that is confidential or privileged and does not constitute an offer for or advice about any
alternative investment product. Past performance is not indicative of future performance. Investors should discuss any investment
with their personal investment counsel or do their own research.
All material presented herein is believed to be reliable but we cannot attest to its accuracy. Opinions expressed here may change
without prior notice.
Precaution: Lies, damned lies, and statistics
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Even though you are seeing stats and comparisons, please be aware that
data may not actually be comparable:
• Banks are applying different accounting standards, importantly when it comes to practices of (not)
consolidating off-balance sheet vehicles
E.g.: JP Morgan Chase & Co., Bank of America Corp. and Wells Fargo & Co. would double in assets if
they applied international standards (according to Thomas Hoenig, vice chairman of FDIC, based on Q3
2012 data)
• Banks have different definitions of non-performing loans and doubtful assets, as well as different
provisioning rules (an issue among others highlighted by the ECB when compiling aggregated bank stats
for the EU)
• Banks’ internal valuations of assets and liabilities may not be comparable, and certain assets are
valued purely based on internal models (an issue among others highlighted by the IMF staff when
conducting the financial stability review of the European banks)
• Risk parameters and risk-weighted assets differ bank-by-bank more than justified by differing risk
profiles (among others highlighted by the EBA when presenting the results of the EU bank stress test
2011)
• Differences in aggregated country-level stats (sample, definitions, etc.)