Is the European banking sector on the brink of a systemic crisis? I have worked for a large European bank for 8 years - pockets of weakness and structural problems are undeniable. But let's look into some data to make a non-emotional assessment. A thread. 1/
After the GFC, the European banking system has delivered below-par return on equity (RoE) for its investors. From a 14-15% RoE in 2007 we are now sitting in the 7-8% area - for comparison: 10%+ in the US and Nordic countries. 2/
Low interest rates affected net interest margin for years, and this comes on top a pretty high cost-to-income ratios: European banks are not very efficient at allocating resources productively. Plus, Europe has another interesting structural problem to handle... 3/
...it has way too many banks! This 2019 study from The Economist shows how most European countries have 2-3x the amount of banks per capita against the US or Australia, for instance. These are only some of the structural challenges, but... 4/
...one of the reasons why income and RoE have been very poor since the GFC lies in the clean-up and additional regulatory constraints imposed by policymakers. For instance, capital has been deployed into cleaning up balance sheets: have a look at non-performing loans. 5/
Also, and very relevant - so far we only talked about income and RoE, but what about liquidity? Post GFC, European banks were asked to keep a Liquidity Coverage Ratio (LCR) > 100%. This means they always must have enough High Quality Liquid Assets (HQLA) to meet... 6/
...deposit outflows in a stressed scenario. Before the GFC, European banks could invest their liquidity buffers much more freely and take on illiquid assets to generate higher returns - much much harder today. Additionally, the ECB has been lending directly to banks... 7/
...at exceptionally cheap rates for years (TLTRO operations). This has further boosted liquidity coverage ratios (LCR) - 110-120% is considered pretty healthy already by regulators. 8/
Ok, so we know that the European banking sector: - Has plenty of structural challenges (we discussed some) - Delivers poor RoE for its investors - But managed to decently clean up its balance sheet and largely improve its liquidity position So, what's next? 9/
There is a lot of chatter about some large European bank on the brink of a crisis. Already in July, I was tweeting this: https://t.co/V2vFkI9MR5 10/
European banks are facing quite a combination of negative cyclical headwinds: - Exposure to Russia/Ukraine basically to be marked to zero, and some EM exposure (EM, CEE) under pressure - Dollar funding to be rolled over in markets (ouch) - Slowing domestic growth 11/
I have definitely NOT been a fan of long European banking exposure in 2022, and continue to be pretty bearish on the sector. But expecting a ''collapse'' seems overstated on the back of the improvement in capital and liquidity positions, and most importantly... 12/
...the quadrillion gazillion derivatives about to bring Deutsche to its knees is mostly bulls**t. Of course the gross notional is gigantic, but how much does it matter if there is an offsetting position? The net derivatives book is waaaay smaller. 13/
The reason why DB and CS are getting hammered is that they belong to a very weak and cyclically exposed sector (European banks) and they suffer from additional idiosyncratic weaknesses. CDS are widening, reflecting wider credit spreads - which makes sense... 14/
...in today's macro environment. Again, I don't like European banks at all here. But a non-emotional, data-driven assessment of the situation hardly calls for a ''widespread collapse'' moment, in my opinion. Pockets of serious weakness will be there, though. 15/
