Pushing to control a larger slice of the EU’s financial pie.
By Don Quijones, Spain & Mexico, editor at WOLF STREET.
There are plenty of reasons to be worried about the state of Europe these days, but if one had to choose one thing above all others, it would be the gaping disconnect between reality and senior European policy makers’ willful misperception of reality.
A perfect case in point was a speech given in Frankfurt by ECB president Mario Draghi. He was addressing a conference of the European Systemic Risk Board (ERSB), an organization created in 2010 by the European Commission to warn about and mitigate systemic financial risks in Europe.
When Small Is Evil
During his address Draghi discussed what he saw as the biggest threats to Europe’s financial system. Just as you’d expect from any senior central banker worth his or her salt, he did not point to the most obvious risk: the zombifying banks at the very top of the financial food chain — the same banks that coincidentally constitute the ECB’s number-one constituency and whose balance sheets are still filled to the rafters with toxic assets dating back to even before the last major crisis, in 2008. By now, virtually all of these banks are fully dependent on the never-ending and ever-growing welfare assistance provided by the ECB.
Nor did Draghi mention the excessive complexity and interconnectedness of the banking system, routinely fingered as potential causes of the next global financial crisis. Nor for that matter did he mention the destructive side effects of the ECB’s negative interest rate policy (NIRP), which – besides sacrificing millions of savers and retirees via their pension funds on the altar of rampant debt creation and completely undermining the crucial micro-economic role played by capital formation – is making it difficult for Europe’s largest banks to turn a meaningful profit.
No, for Draghi, the biggest financial problem in Europe these days is that it is over-banked. “Over-capacity in some national banking sectors, and the ensuing intensity of competition, exacerbates this squeeze on margins,” he said.
Put simply, there’s just too much competition from the thousands of smaller banks that are crowding out the profits for the big banks.
Consolidation and Concentration
The solution is clear: lots and lots of cross-border mergers that will finally convert Europe into a genuine single financial market, while also enhancing the concentration and consolidation of the sector. This is not the first time that the ECB has called for the two “Cs”. As we warned over two years ago, it was one of the crowning goals of European banking union.
One big problem Draghi faces in achieving this vision is that the ECB only has control over Europe’s 130 biggest banks. The other 6,000 or so smaller institutions — the local and regional savings banks and cooperative lenders that by and large continue to offer some semblance of financial service to local communities and businesses — are currently still under the supervision of national regulators.
As far as Europe’s most important national financial regulator, the German Bundesbank, is concerned, that’s how it should stay.
In Germany the two biggest lenders — Deutsche Bank, whose share got bashed down to record lows today, and Commerzbank — account for roughly one-quarter of Germany’s financial sector. The other three-quarters are made up of regional banks, local savings banks, cooperative lenders, and mutual associations that play a vital role in funding not just the small and medium-size firms of Germany’s Mittelstand but also global giants like Volkswagen.
For the German government and central bank, handing control of the remaining 75% of the country’s financial system to the ECB would be a step too far.
Zombie + Zombie = Super Zombie
Another major obstacle to Draghi’s plan to drastically thin Europe’s banking herd is the torrid state of many of Europe’s biggest banks. Put simply, very few banks want to buy or merge with other bank, since they have no idea just how serious their rival institutions’ problems are.
It’s no coincidence that mergers of Western European banks are at their lowest point in years, according to Bloomberg. In 2012, €49 billion was splashed on financial sector mergers in Europe. By 2015 that amount had shrunk to just €12.1 billion.
As the Bankia example amply showed, merging one insolvent institution with another (or others) merely compounds their problems. Bankia was spawned in 2011 from the ill-fated merger of seven insolvent savings banks, only to collapse in 2012.
What’s more, the European banking sector’s most serious problem is the level of concentration – the mega banks that seem to be able to keep growing – and the fact that their sheer size and systemic importance make them impossible to resolve.
In the ultimate irony, just across the way from where Draghi was blaming Europe’s financial problems on its smallest banks, the decline and fall of Deutsche Bank continues apace. In Italy, the country’s third largest bank, Monte dei Paschi di Siena, is even further down the path toward outright zombification. Judging by recent reports, Italy’s largest bank, Unicredit, is not far behind.
In each case, massive taxpayer-funded infusions are on the horizon, even if they contravene the new bail-in rules brought into effect at the beginning of this year. In the case of Deutsche, whose books are rammed full with highly risky derivative products, a bailout may not even be enough.
Finally, a bank that is ostensibly too-big-to-fail might actually fail, putting at risk the entire global financial system. In the meantime, Europe’s most senior central banker, who wants to grab more power by consolidating a larger percentage of the EU’s financial sector in his bailiwick, is worried about the competition risks posed by the continent’s smallest banks. By Don Quijones, Raging Bull-Shit.
With a stagnating economy, even supposedly good loans on the books of Italian banks may end up putrefying. Read… Italian Banking Crisis Turns into Mission Impossible