#EuropeanBankingShock may well be next source of global economic crisis

| August 16, 2019

11 years after the global financial crisis, the European banking industry is once again preparing for tough days ahead. After Deutsche Bank’s announcement of a large-scale layoff plan recently, another large European bank may go down the same path. Similarly, UniCredit is considering cutting 10,000 jobs and this made up the 10% of the bank’s total global workforce. With the announcement of its business plan for 2020-2023 scheduled in December this year, it is expected that most of those retrenched will be its Italian employees, write Chen Gong and Karl C.L. Lee. 

As Italy’s largest bank by asset size, UniCredit is a European bank headquartered in Milan, with operations in 19 countries and owning more than 28 million customers. It is also one of the prominent banking conglomerates in Europe with business outreach in the more well-off regions of Italy, Austria, southern Germany as well as those in Central and Eastern European countries. With assets of €91 billion, UniCredit is currently the largest bank in the Eurozone, the third largest in Europe and the sixth largest in the world. However, its profitability is declining in recent years and according to Financial Times, UniCredit’s net profit for 2018 had declined by nearly 29% to €3.89bn as compared to €5.473 billion in 2017.

These two cases of massive layoffs could be a possible indication that the European banking industry has not fully recovered from the European debt crisis. Whilst the US adopted quantitative easing and accommodative fiscal policies as well as embarking on legislative measures to strengthen supervision of the banking industry, there was a lack of a unified fiscal policy in Europe in response to the debt crisis. It was only in November 2014 ⸺ four years after the occurrence of the crisis ⸺ that a single regulatory mechanism for the banking sector in the EU was launched. Compounding that is the lack of sufficient policy support for the de-leveraging process of the European banking industry that slowed the whole process of economic recovery. Again, this was starkly different than their American counterpart which accelerated its de-leveraging process after the debt crisis. As of now, total loans of 27 European banks have recorded higher proportion of non-financial debts as opposed to their American counterparts, an indicator that the former’s profitability is shrinking due to the need to service such debts.

The banking performance-economic growth nexus

At a more general level, the poor performance of the European banking industry stemmed from the slow recovery of the European economy and the tightening of banking regulations. Data from the World Bank reveals that from 2010 to 2017, the world’s GDP increased from US$65.96 trillion to US$80.73trn, representing an increase of 22.39%. Among them, the US’s GDP increased by 29.61%, from US$14.96trn to US$19.39trn; whereas the EU’s GDP only increased by a mere 1.76% (from US$16.98trn to US$17.28trn). In short, the economic growth of the EU is not only significantly lower than the global average but also, lower than the US.

The reason European banking performance is closely related to its economic growth is because European banks (especially small and medium-sized banks) are not highly globalized and their businesses are mainly located in the continent. Only a few larger banks, such as Deutsche Bank, have branches around the world that provide services to customers globally. As the global trade frictions intensify and the downward pressure on the economy increases, the profits of these large banks are being affected. Small and medium-sized banks whose businesses are mainly concentrated in Europe will see difficulty in improving their profitability.

After the European debt crisis, there is a tightening of regulation within European countries. For certain, the debt crisis has exposed two systemic problems of the European banking industry: banks engaging in higher-risk businesses and under-regulation of the EU’s financial system. In resolving these problems, the EU has increased the banking capital adequacy requirements by prohibiting large banks from engaging in proprietary trading and curbing excessive speculation in the banking industry. On the other hand, it also formed the unified regulatory mechanism which includes the clearing mechanism and deposit insurance system for its member states. While these two measures had stabilised the banking industry by increasing the capital adequacy ratio and the divestiture of risky assets, they also contributed to the decline of profitability among European banks.

Another banking crisis looming?

Kevin Dowd, a professor of finance and economics at Durham University, is of the view that the EU’s major banking problem is self-made. For one, both quantitative easing policies and excessive tolerance policies have worsened the repayment crisis, which has already been long-standing for the EU. As such, Dowd believes that the European banking industry is heading for crisis and the current bad debt loaning solution practised by its banks will fail eventually. In the end, there will be the scenario in which taxpayers will have to bailout the banking industry as it has become too big to fail.

In all, it is worthy to note that both Deutsche Bank and UniCredit are regarded as banks with high importance in the European financial system. If these banks are having problems, they will inevitably produce impacts over the European financial system. Given such long-existing problem alongside the US-China trade war that resulted in global economic slowdown, the European Central Bank (ECB) is expected to introduce easing policies and even cut interest rates further in order to prop-up the economy. Should the interest rates fall further, it will add weight to the long-term negative interest rates that have already affected the profitability of the European banking industry. With these banks slated to face increased profitability problem, it will then affect the lending behaviours of European enterprises and possibly, dragging down the economic growth of the EU. If such banking shock continues to expand within the vicious cycle, it may trigger a new round of global economic crisis.

Founder of Anbound Think Tank in 1993, Chen Gong is now ANBOUND Chief Researcher. Chen Gong is one of China’s renowned experts in information analysis. Most of Chen Gong’s outstanding academic research activities are in economic information analysis, particularly in the area of public policy.

Karl C.L. Lee is PhD Candidate at the School of Arts and Social Sciences, Monash University (Malaysia Campus). He was also the Visiting Scholar at the School of Politics and Public Administration, Guangxi University for Nationalities (GXUN) under the 2017/2018 Chinese Government Scholarship (Bilateral Program)


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