Is the European Banking Industry Set for a Fall in 2016?

European banking failAn affirmative “no” appears to be the general consensus from those high up the ranks in the European banking industry as to whether the financial crisis that beset the world’s banks in 2008 and 2009 is due for a return.  Regulators have put in place a considerable amount of liquidity stress testing for the European banking system in the face of the 08-09 crisis.

Going into the 2008 crisis, the regulators did not have the information they needed to be able to assess the banks’ strength, how well capitalised they were and what risk positions they had that could blow up. Seven years on, despite the fact that they can’t control banking compensation, regulators have a far clearer idea of what banks’ risks are and have been poring over them and stress-testing to a point where there’s very little that isn’t known.

Though the extent of collateral damage done during the 08-09 crisis is unlikely to reoccur, we are likely to see some banks struggle to maintain their size and capacity. Some leading banks may be forced to downsize as they don’t have the capital needed to support their businesses. Under pressure from regulators to practice more conservatively, the requirement to put aside capital for some of their riskier businesses has left them with two options; the first to request more capital from their shareholders is complex as this may well impact negatively on their share price and therefore the likely alternate option is to downsize their business.

As a rule, investment in emerging and third world banking is regarded as riskier than European and North American, and with the prospect of requiring more capital, leading Banks have opted to sell to reduce their risk position. Lending in weaker economies for example in Africa is often seen as far riskier due to the commodity-based nature of these markets, historical trends show a causal link between commodity prices and emerging market performance.

While some leading banks have made minor adjustments, others have been significant such as a top retail bank’s much publicised recent decision to sell their entire South African business.   Wanting to avoid a cut in share price, the bank opted to reduce their dividend by selling their African business, this style of reaction is likely to be repeated by others as a result of the growing regulatory requirement across Europe. A leading banker says “If banks are now being required to put up more capital for various businesses, they are going to be much more careful about choosing which businesses to stay with and the returns they require from them.”

Over the next couple of years we are likely to see banks shrink their business in the face of increased fines and the imposition of sanctions. In short, banks will endeavour to reduce their risk following pressure from the regulators. A consequence of this may be that as European banks shrink, they become less attractive to investors; rather this though than a collapse in the manner of HBOS and RBS.

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Our Renaix Guide to Governance, Risk, Compliance and Internal Controls provides information on trends in the industry.

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23-06-2016

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