European Zombies

What’s at stake: European banks have made a come back to the forefront over the past few weeks. Whether it be the fall out of their exposure to Dubai World, changes in the regulatory system or the activism of the European Commission when it comes to pushing through restructuring in compliance with rules for the internal market, European Banks are definitely back at the centre of European economic policy. Our focus is here on banks’ profits and losses.

On banks’ expected losses…

The Bundesbank's Financial Stability Review argued on Wednesday that losses stemming from securities have been largely accounted for if not overstated but losses from the cycle in 2010 could be understated. The range of write downs expectations for 2010 is comprised between EUR 50 and 75bn but the report acknowledges that bank specific factors – which have previously been of lesser significance – will acquire greater importance.

RGE Analysts Salman Ahmed and Elisa Parisi-Capone, revisiting the issue of bank losses they expect in the eurozone, argue that the amount of stress in the eurozone and the U.S. banking system is comparable, although stemming from different sources. Whereas the U.S. banking system is mostly exposed to the domestic economy, a significant share of eurozone losses stems from abroad.

The Committee of European Banking Supervisors released its latest European projection of banks' losses in October. Unlike the estimates released by the IMF, RGE or McKinsey, the CEBS study is the only along that of the ECB that uses enough granular single-entity information. The results show a fairly modest reduction in losses estimates since the ECB report released in June and show convergence with the IMF's estimate released in September suggesting that there is increasing convergence on the estimate of bank's losses in Europe at a fairly high level.

FT Alphaville reports that European banks are most exposed to United Arab Emirates debt. Although the exact exposure of European Banks is unknown, the Emirates Banking Association has released data that are extracted from the Bank for International Settlements which show that United Kingdom banks are the most exposed to the UAE. According to the Bank for International Settlements, banks have claims totalling $123bn on debtors in the UAE, $88bn of which are held by European banks and $50bn by UK banks alone. Against those losses, the impact of downfall of Dubai World on European Banks and the global financial system seems moderate.

And current profits!

Helen Rey looks at bank profits and argues that they mainly result from market distortions created by the crisis: increased market concentration, free implicit government guarantees and close to zero liquidity costs. But despite the severity of this crisis, the banking sector has still not become better supervised. Elie Cohen says that although this is all true, European leaders should refrain from punitive measures such as special taxes against the financial industry. Paul Krugman disagrees and argues for a Turner-Brown Tobin tax on the financial sector.

Aviram Levy and Fabio Panetta argue that government guarantees on bank funding should be extended into 2010 despite the improved bank profitability and the schemes’ distortionary effects. The guarantee schemes were meant to help banks retain access to wholesale funding in the aftermath of Lehman Brothers’ demise, when money and corporate bond markets were severely disrupted. And as of end-September 2009, close to 1,100 bonds totalling the equivalent of €760 billion had been issued in G10 countries by roughly 180 financial institutions. Despite recent improvements in economic and financial conditions, the authors argue that the EU authorities should extend the guarantees into 2010 as a precautionary step. However, when doing so, governments should correct the schemes for some distortionary effects in particular regarding the pricing mechanism, and accompany them with a credible exit strategy.

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