European Banks and Why the Deleveraging Has Only Just Begun

By Martin T., Macronomics

“Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.” – Winston Churchill

Figure 1 was extracted from Bank of America’s note “Banking on the Banks” from the 16th of May, clearly illustrates why the deleveraging has only just started in Europe.

“Meanwhile, Europe continues to lag the improvements seen in the US economy and markets. Quite simply, Europe’s economy struggles with too many banks, too much debt and too little growth. A long history of empire, trade, war and commerce means a long history of banking. The world’s first state-guaranteed bank was the Bank of Venice, founded in 1157, and the world’s oldest bank today is also Italian, Monte Paschi di Siena (founded 1472). In many European countries, bank assets dwarf the size of the local economy and are far in excess of other regions in the world.” – source Bank of America Merrill Lynch.

Why the credit crunch in European countries?  Because this deleveraging was accelerated by the fateful decision taken by the European Banking Association of imposing European banks to reach a Core Tier 1 capital ratio of 9% by June 2012. It has not only broken the credit transmission mechanism to the real economy in Europe but caused a credit crunch as well (see figure 2).

mt1(Figure 1 – bank assets as % of GDP)


(Figure 2 – EU private sector credit growth)


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Martin T., Macronomics

Martin T. is a credit specialist with a London based bank. During his career he's had different roles within various banks, covering everything from FX to High Grade Bonds. He has always been passionate about markets and particularly on Macro trends.

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  • Eddie T. Peterson

    Without an agreement by the end of Monday, Cyprus had faced certain banking collapse and risked becoming the first country to be pushed out of the European single currency – a fate that Germany and other northern creditors seemed willing to inflict on a nation that accounts for just a tiny fraction of the euro economy and whose banks they felt had overreached themselves.

  • Matt McOsker

    So bank assets as a % of GDP seems higher in countries that have been trying to run small deficits and have more onerous tax structures. Can we assume that is the result of the private sector being driven into debt as a result of high taxes and small deficits?

  • Johnny Evers

    Private sector credit growth in Ireland was fueled by loans taken out to build houses that were never occupied.
    So, yes, credit growth is falling, but that’s a good thing, isn’t it?

  • Boston Larry

    How long is the fuse on the coming explosion of a European bank. Sure Mario Draghi will do his best to step in and add that bank’s bad assets to the books of the ECB. What if he does this a couple times and then the Germans won’t let him do that any more?

  • Martin T

    Credit is like cholesterol, there is good and bad. That the private sector is deleveraging after a credit bing is a good thing, but that good cholesterol, is, like essential credit to the real economy such as small businesses is not provided because of impaired banks balance sheet is indeed a very bad thing.

    On the comparison between Ireland and Iceland I highly recommend reading the following article by Dr Gurdgiev: