Europe's banking system is not as robust as it may seem

08 October 2018 7 min. read

The financial crisis saw almost the complete meltdown of the global financial system, requiring considerable state interventions to stave off the crisis. While recovery has picked up in Europe, the European banking system is not as robust as it may seem, warns a new report, mounting concerns that current non-performing debt levels could see another crisis unfold.

The financial crisis of 2008 unleashed a severe economic downturn, creating headaches for states as many financial institutions – including Lloyds and RBS in the UK, ING in the Netherlands, and Bankia in Spain – required state backing to stay afloat. The aftermath of the crises saw considerable regulation introduced, with the idea that better risk & compliance and oversight of financial industry players would lower the odds of a future crisis, as well as structures to wind down failed banks and poorly performing loan books.

The effect of the crisis saw many European banks hobbled by debt, with various countries – particularly Greece, Italy and Spain, continuing to note particularly high levels of non-performing loans (NPL) on their loan books.

NPLs in the EU by country

A decade down the line, Europe has since seen its economy recover, with GDP growth on the rise. Greece was the hardest hit during the crisis – the country only recently returned to positive GDP growth. Space and Italy too saw challenging years during the start of the decade, with Italy returning to >1% growth last year, while Spain rebounded sharply in 2015, noting three years of >3% growth. Germany and France have booked positive growth since 2012, although growth has been slow to increase above 1% in France, while Germany returned to almost 2% growth in 2014. Across the EU28 as a whole, growth managed to return to above 2% in 2015, and topped 2.4% last year.

Are banks ready for the next crisis?

Yet crises are by no means over – and the next one could strike at any time, warn economists. In a new report by Oliver Wyman, the authors consider to what extent financial institutions are prepared for a new crises and explore possible tactics they can leverage to avoid future none performing loans from hobbling their books. The report, titled ‘Is Europe Ready for the Next Crisis?’, was conducted by the firm’s Corporate Restructuring service line.

The authors highlight that while growth levels are now positive, debt levels have remained high globally. Debt as a % of global GDP increased from around 195% prior to the crises to a peak of 215% at the height of the crises. However, while dropping in the years to 2014, debt again rose since then, reaching 227% in 2016.

Global Debt

Meanwhile, in Europe’s banking sector, non-performing loans as a % of gross loans are understandably high in crisis hit Greece, but relatively lower in Italy and Spain, at 11.8% and 4.8% respectively. Across Europe as a whole, non-performing loans stood at 4.2%. “The European banking system still suffers from a heavy burden of problem loans. The overall ratio of “non-performing loans (NPL)” has still not fallen below the pre-crisis level, and some countries still carry double-digit NPL ratios,” said Lutz Jaede, Head of Corporate Restructuring at Oliver Wyman.

The study finds that some banks continue to hold the hangover from the previous crises, create risks going forward if another crises at the magnitude of 2008’s event hits the landscape’s frontiers. Being prepared for the next crises is a key aspect of wider oversight currently being implemented in the financial system in Europe, including more stringent capital requirements and elaborate stress testing on economic scenario’s. Banks have further become more bullish in their lending, with criteria for loans becoming less stringent in the past number of years as the new state of affairs matures.

Loan restructuring

Banks have also changed tack when it comes to restructuring if a loan looks like it is going sour; the survey found that banks are more likely to monitor debtors at risk (58%), while special task forces have been developed to restructure if a company appears to be failing to meet its requirements (74%). Banks are also keen to sell on NPF earlier than in the pre-crises years. These and a number of other measures, aim to reduce the risk of loans at the individual level – however, if a structural downturn hits, questions about bank preparedness remains a pressing one.

What instruments do you have in place in order to prepare for a crisis?

According to the respondents surveyed by Oliver Wyman – banking executives and restructuring officers – the overall capability of banks with regards to steering instruments required to monitor and act upon crisis situations is significantly more mature compared to ten years ago. Most of the surveyed managers stated that they have implemented good reporting on profitability and operational performance and that they use a rolling liquidity forecast in combination with a mid-term planning to plan the company’s development. Jaede however placed a side note on confidence, stating “these instruments are most appropriate for managing a steady state but do not anticipate major shifts or long-term challenges.”

Concern that a downturn could affect one market, or the whole market, continue to simmer – largely due to geopolitical uncertainties, cyclical fundamentals, as well as key latent risks that could be triggered by political or environmental conditions turning south. The global consulting firm noted that one way to reduce market risk is for improved transparency from debtors about their fundamentals – allowing banks to move earlier to mitigate losses to the company and the wider economy in a downturn.

Collaboration between banks and corporates to avoid a crisis

The researchers further highlighted that banks in general are not happy with the level of collaboration across key metrics that can be used to model both market collapses, as well as company performances – something with which corporates stand at considerable odds to in terms of their self-judged level of collaboration.

Jaede: “In order to avoid a crisis, it is essential that banks and corporates collaborate closely with regards to early identification of a potential crisis event, transparency on a company’s situations and performance, timely information on financing needs, and proper management and coordination of different financing partners. Our survey shows that banks are not pleased with the performance of their debtors in these areas. The corporates, however, do not feel a significant need for improvement here.”

Key differences are noted in terms of proactive communication in case of extraordinary incidents, with a score of 2.7 for banks (with five as ‘managed very well’) and 4.0 from corporates. Timely and constructive dialogue on upcoming financial needs too saw divergent scores of 3.2 – 3.9.

Concluding, lead author Jaede said that while the current mood is good driven by solid economic development, the European banking system is not as robust as it may seem. “Executives feel confident in the face of crisis – but at Oliver Wyman, we have our concerns.”

Related: Banks turn to investors as means to improve restructuring of NPLs.