International Trade and Finance Association
20th International Conference Working Papers
Year Paper
BANKING IN EUROPE, BANKING ON EUROPE: LESSONS IN CRISIS AND RESOLUTION Irene Finel-Honigman Columbia University
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Abstract
This paper examines the impact of the financial and currency crisis on EU and non EU banks in the context of the last two decades (1990-2010) conceptual strategies, public-private sector political and economic policies and the approach toward Anglo-American capitalism.
EU banks have weathered the worst of 2008 relatively unscathed, but have been buffeted by the impact of the Greek debt crisis of 2010.
It considers the lessons of history and presents a prognosis.
This paper was presented at the twentieth international conference of the Inter- national Trade and Finance Association in Las Vegas, Nevada, May 24, 2010. International Trade and Finance Association: 20th International Conference Working Papers
This paper examines the impact of the financial and currency crisis on EU and non EU banks in the context of the last two decades (1990-2010) conceptual strategies, public- private sector political and economic policies and the approach toward Anglo-American capitalism. EU banks have weathered the worst of 2008 relatively unscathed, but have been buffeted by the impact of the Greek debt crisis of 2010. What are the lessons of history and what is the prognosis?
SHIFTING SANDS
On May 9, 2010 before the Asian markets opened, the European Union announced a coordinated nearly $1 trillion Emergency Fund to bolster the euro and guarantee a safety net for all eurozone economies. Put together in coordination with the ECB and the IMF this announcement prior to the opening of the markets Monday morning , following a week of violence in Greece and extreme volatility ( 1000 point drop) on the NYSE , created a sense of relief and respite to global markets. The markets responded with enthusiasm, with a 400 point hike on the NYSE and banks across Europe including in the besieged PIIGS posted 12% jump in Spain,7% in Ireland and a 9% hike, even in Greece. Deutsche Bank shares rose 12% and Societe Generale heavily exposed to Greek debt up 21%. Market panic not only stopped, it appeared to be replaced by market euphoria as the EU clearly send a message that they would support the euro and all member countries.
Short term this was a very welcome respite from the gloom and doom scenarios of the last three months, but in reality nothing fundamentally changed. Greece remains extremely fragile, Portugal, Spain, Italy, Ireland need to maintain strict austerity and monitoring in place, Germany still had to give final approval for a very unpopular bailout package and the UK ( although not in the eurozone) in the aftermath of a contentious election has to put in place draconian austerity measures. But the Emergency Fund did prove that once again , as in September 2008, European governments led by France, Germany and the UK saw the need to bailout their financial sectors and did so efficiently and in unison.
The Crisis of 2008 which was primarily a financial crisis, focusing on the banking sectors, had morphed into a currency crisis in spring 2009 and again into a potential financial crisis which had to be averted.
The three month old crisis has been allowed to fester due to political posturing, rivalries and fear of loss of prestige between France Germany , the IMF and the ECB. Despite the 160 billion euro package proposed by May 6 by the IMF and ECB, there was a risk of potential bank crises as the extent of French, German and Swiss bank exposure to Greece surfaced. Even RBS and HSBC had higher than foreseen exposure to Greek debt.
The fear of Greece defaulting rocked highly volatile markets exacerbated by revelations of French banks higher than assumed exposure to Greek government bonds.:
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“Societe Generale yesterday revealed for the first time a €3bn( $3.9bn) exposure to Greek government bonds” (FT May 6, 2010) despite posting excellent first quarter net profit; “BNP post profit but reveals €8bn of assets exposed to Greece” ( FT, May 7, 2010) comprised of €5bn in sovereign bonds and €3bn of loans to Greek companies. As of early May, Credit Agricole held €850million and Natxix, €954 million of Greek bonds.
The conflation of Greece’s debt crisis with Portugal, Italy, Ireland and Spain ( PIIGS) confused rather than clarified the situation. Both French Finance Minister, Christine Lagarde and Bundesbank President Alex Weber ( potential successor to Trichet at the ECB) tried to insert some reason and perspective into the media driven barrage of “eurozone collapse” scenarios.
The fear of contagion was fueled by a spiraling loss of confidence in Greece’s ability to implement austerity measures required by the ECB IMF package and moreover by its inability to control domestic unrest which deteriorated in the week of May 2 from union led mass demonstrations to senseless violence and deaths of three bank workers in Athens. But the question remained: was the Euro rescue package in truth an EU bank bailout?
FINANCIAL CRISIS RESPONSES
In September 2008 the first reaction from EU banks was to accuse America of “ cowboy capitalism”, lack of morality, unethical behavior and collusion between big banks and government (the arguments resurfaced in the Goldman Sachs hearings, SEC complaint and revelations of the derivative transactions with Greece in 2001).
However taking the high ground lost its impact within a week, once it was revealed that Spain, UK, Ireland, Germany and non EU (Norway, Switzerland, Iceland) countries had exposure to subprime mortgage loans or in the case of Ireland and Spain to an inflated real estate market. The German public and media were shocked to learn that the most traditionally conservative German Landesbanken after the loss of state subsidies under EU regulation in 1999 had sought high yield, high risk transactions and had begun to default by the summer of 2007. French banks, BNP despite losses due to Madoff feeder funds and Societe Generale despite substantial losses due to the Jerome Kerviel fraudulent trading scandal appeared basically unscathed. Within one week, the Belgium Dutch bank Fortis and French British Dexia collapsed. By 2009 BNP acquired Fortis adding Belgium and Luxembourg markets to its retail operation , which would prove profitable.
The UK which had undergone its first shock in the failure and privatization of Northern Rock in the fall of 2007 saw the need to undertake partial privatization of Royal Bank of Scotland, Lloyds, and even Barclays.
Whether directly affected or not, all EU governments required that major banks accept injections of capital and basically return to the fold of government ownership, influence and supervision under national central banks.
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Overall European governments led by Merkel, Sarkozy and Gordon Brown acted quickly and extremely efficiently in coordination with the ECB and the Fed to insure all bank liabilities, increase deposit insurance, fend off public panic and bank runs and maintain stability.
The meltdown in Iceland, the near default in Hungary and Latvia, the endemic weakness in all post 2004 member countries with the exception of Poland, made it clear that the ECB and the IMF had to assume far more aggressive roles, often on an ad hoc basis when any country within or outside of the eurozone was in danger of financial collapse or default. Post 2004 ( former CEE) members were the worst affected as the Crisis revealed inherent weakness in a majority foreign owned banking sector which had fueled lending sprees in euros and encouraged real estate speculation.
RESULTS OF 2010
Yet within less than two years , banks appeared to have recovered and were in fact beginning to post substantial profits for last quarter of 2009. Until the severity of the Greek crisis revealed major fault lines across the eurozone, major European banks seemed to have even surpassed pre 2008 levels of profitability.
Overall the banking sector has not undergone the major realignment imposed on US banks where the only investment banks left, Morgan Stanley and Goldman are still under bank holding status since September 2008, In Europe the landscape has undergone far less radical surgery. The top banks, Santander, BNP, Credit Agricole (CALYON),HSBC, Deutsche ,Commerz - Dresdner, Unicredito ,and even RSB and Barclays Capital have remained intact. Despite loss of prestige, unprecedented scrutiny due to tax collusion and exposure to Madoff, UBS has also gone through the crisis with minimal damage.
Even in the UK, Royal Bank of Scotland, assumed near death in 2008 has not been broken up and Barclays, Lloyds were reverting to profitability. Ironically Barclays Capital which under the aegis of the British Financial Service Authority rejected coming in as savior for Lehman in September 2008 posted profits up nearly 47% for 2010, profiting from the sale of Lehman assets. 2009 reports show Deutsche profits up 24%. BNP (having incorporated the failing Fortis Bank) Commerz following the finalized Commerz-Dresdner merger in May 2009, HSBC and Santander all finished 2009 in the black. Even Irish banks under government control and severe austerity measures were regaining market credibility and a resurgence of foreign investment. Ireland had to undergo radical changes as the process of spinning off toxic loans had to evolve under the NAMA (National Asset Management Agency), the “bad bank” concept similar to the Securum in Sweden (1993) , CDR in France for Credit Lyonnais (1995).
These results lend credence to a steady global recovery, yet the counterpoint of political volatility, anti-incumbancy ( the UK elections) , rise of extremist movements on both ends of the political spectrum and general distrust of government and markets reveal a far more fragile landscape fraught with public distrust of banks and markets. The
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perception remains that large banks’ ability to repay government bailouts occurred at the expense of taxpayers and stakeholders, while benefiting shareholders and bank senior management. Banks are still not lending at pre 2008 levels, charges to customers, depositors have increased while dividends have decreased.
EU and non EU countries like the US remain in a paradoxical situation: bank sectors seemingly recovering, but high unemployment and lagging indicators barely coming out of a severe recession.
For post 2004 members which had been the most severely affected by the Crisis of 2008, their currencies buffeted, near default ( Hungary and Latvia had be bailed out by the IMF with ECB assistance) and banking system , nearly 80% foreign owned at the mercy of Austrian , Italian , Swedish, shareholders, the recovery has been tenuous at best. Yet by May 2010, Raiffeisen, Erste and Unicredit are again extending euro loans instead of encouraging local currency loans and investment. . Although Swedish banks with large stakes in Baltic banks assumed responsibility during the crisis :” they are new democracies, they are part of our economic region” (NYTimes, March 13, 2009), the question remains whether these arrangements of dependency and possible exploitation will continue.
Financial sectors across the EU function under a two tier system in which core countries in the name of economic patriotism have not allowed foreign majority shareholdings , yet the peripheral post 2004 members have given over their sectors. Although there will be a long hiatus before the EU extends Eurozone membership, much less resumes enlargement, Estonia enthusiastically came into the Eurozone in June 2010. Despite the Greek crisis , it appears that membership had proven to be more beneficial than detrimental in times of global downturn or financial crisis.
Political ironies abound as the sole country banking sector beneficiary of the Greek crisis is Turkey. The largest bank in Greece, National Bank of Greece plans to open 75 branches in Turkey and depends on Turkey with a growth of 5% in 2009 o help bolster trade and investment ( Bloomberg, May 10, 2010) Turkey, rejected by the EU in 2005 and on permanent waiting list is today a necessary component in Greece’s potential recovery or at least stabilization..
REMEMBERANCE OF THINGS PAST
Although banks have had to accept government intervention, the fundamental public-private sector relationship set in place in the late eighties and nineties has not been fundamentally altered.
In the United States, the Crisis and subsequent reforms have forced a reexamination of the repeal of Glass Stagall, the reversion to firewalls, the nature of transactions within retail and investment banks. In the EU, issues of too –big to fail, resolution authority , rules of conduct for derivatives, accountability and risk management models are all part of ongoing regulatory proposals and reforms, but the universal banking model and the
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intersection of government and private sector cooperation in times of crisis has been left intact.
Europe will finally have to refine the specific roles of lender of last resort, cooperation between national central banks, the European Central Bank and multilaterals, the role of Basel II and III, but it remains understood that in times of ultimate crises, governments step in.
The universal banking model in place since the 1860s in France and the 1880s in Germany proved resilient allowing changes to occur within institutions , reducing exposure to investment activities, adapting risk management tactics, centralizing and tightening internal supervision on trading activities, focusing on domestic and reducing foreign exposure when necessary, reducing (although not divesting ) foreign subsidiaries, better managing compensation and bonus structure without fundamentally breaking up the organizational structure or internal policies of the institution.
Despite rumors and media driven panic that the eurozone or even the EU would collapse due to the Greek crisis, leaders never envisaged a return to the banking landscape of early 1990s. In 1992 the two largest French banks ( Credit Lyonnais, BNP) were still state owned with strong government stake-holdings throughout the entire sector. Italian banking was a fragmented system of federal, regional, municipal and church ownerships racked by collusion and corruption following the Banco d’Ambrosiano scandal. Banco Banesto,and Santander were modest domestic banks, while Spain remained a back water. The Nordic sector comprised of small indigenous banks dependent on USSR trade was on the verge of crisis. British banks liberated by Big Bang in 1986 led the market: Barings, Barclays, Lloyds, RBS and HSBC. In Germany following reunification the large banks Deutsche, Commerz and Dresdner remained dominant with a state subsidized Landesbanken (regional banks) focused on the domestic market.
Neither are EU governments nor markets willing to relive the total breakdown of currency parity in the currency crisis of 1992-1993, when loss of faith in Maastricht ( following the weak ”petit oui” French vote) set off a speculative frenzy against the French franc, forcing all other currencies to drop out of the EMS leaving only the Bundesbank and the DM to bolster the franc and start the long road back to monetary unification.
The fall of the Soviet Union, the creation of the European Union, the beginning of economic recovery after the severe recession of 1991-1993, the start of the European Monetary Union following the currency crisis of 1992-1993 was accompanied by series of shocks, reversals and major restructuring in the banks and financial markets. Within a decade Europe would undergo waves of privatization, reform , consolidation , deregulation at times following the US model and at times setting forth its own model for transference from public to private sector, increasing efficiencies and profitability. Between 1991 and 1996 the Nordic sector underwent cataclysmic upheaval, requiring government bailouts, the creation of the “bad bank” model, recapitalization and cross border mergers creating Nordbanken-Merita in 1997 leading to Nordea.
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Banco Banesto’s need for a bailout in 1994 and subsequently being acquired by Santander began a process of consolidation and growth for Banco Santander which would culminate in the Spanish banking sector international expansion into Latin America and into first place among EU banks.
In 1995 France’s largest corporate bank, Credit Lyonnais had to be bailed out and under new EU regulatory rulings gradually privatized; the UK saw the demise of its oldest merchant bank Barings, when a bailout was denied. The Italian sector finally underwent consolidation and internal reforms. These events were often painful, with complex political ramifications and reevaluation of the role of the state. Financial reform remained a work in progress as the complexities of multinational financial traditions, requirements and policies had to be coordinated.
Between 1996 and 2007 in a boom economy, European banks pushed mergers and consolidation in all core mature EU countries. In former CEE countries, post 1998 60% to 80% of the banking sector was taken over by major EU banks. In 2007 the EU had enlarged from 15 to 27 countries with 16 of these countries in the euro zone The advent of the ECB in 1998 and the Euro in 1999 as mandated under the Maastricht Treaty transformed the economic , monetary and banking landscape.
Yet the predicted “pan European “ banking based on cross border mergers as advocated in the Second Banking Directive and Open Passport in 1993 did not materialize till 2004. Led by Santander successful acquisition of Abbey National in 2004, and the Santander, RBS , Fortis buyout of ANBAmbro in 2007 (which fell apart in 2008), cross borders mergers have been far more difficult to achieve and to execute.
A decade of scandals, losses, crisis, near insolvencies or failures taught banks how to adapt and survive. In 2008 the field was smaller, the banks larger, but the demands of global competition and the impetus of a revived and aggressive American sector encouraged greater risk and greater rewards.
Despite protestations against American style capitalism and despite the need to accept government funding, aid packages and partial or full interim nationalization in 2008, neither EU governments, banks nor markets have advocated a return to an era of government ownership or majority shareholdings, limited competition and smaller , domestically focused markets.
The conundrum facing EU banks is how to incorporate more stringent regulation , government imposed rules of conduct, greater accountability and cross border sharing of information, while maintaining the competitive and profit driven ethos of the past two decades.
Regulatory reform ( Larrosiere Plan, the Darling and Osborne plans , the Dodd-Frank bill) are all cognizant of market pressures and need to regulate all areas of international finance , impose stricter penalties on banks, greater supervision and accountability, the interrelationship between private equity and banks and achieve clarity “ transparency “ in
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use and operations of derivatives and other esoteric instruments. Compensation which reached dizzying heights but nowhere near US levels also need to be redefined and under stricter rules.
LET THERE BE LIGHT The lessons to be learned and hopefully applied across the EU are that in times of crisis governments can and will intervene: regulatory reform will have to clarify the role of national central banks and the ECB, the intersecting roles of the ECB and the IMF and specify under which conditions government and central bank intervention can occur. In each EU country in the fall of 2008 government provided capital injections and took stake holdings in the large banks. Government intervention did not necessarily impact institutional integrity of banks nor as proven in 2008 did it imply government takeover long term. But as centrist political and monetary philosophies have firmly turned from demand to market economies in the last decade, in order for banks to remain in the private sector, there will have to be stringent internal housecleaning and systemic reforms. Societe Generale, BNP, the German Landesbanken , the Spanish “cajos” and the Greek banking sector are the most blatant examples.
The Greek crisis proved the need for far greater coordination , sharing of information and disclosure of weak or toxic loans. Exposure to Greek debt remained a tightly held secret on major banks’ balance sheets for years. The stress tests in 2010 , modeled on the US are a first step, but disclosing the full extent of the damage and exposure will take months in a highly volatile global environment.
The Crisis of 2008 and 2010 proved the interconnectivity and fragile balance between monetary and financial crisis: speculative attacks on the Euro immediately revealed the levels of exposure and risk for all member country banks and markets. Delayed reactions and revelations of real losses over weeks in 2008 and over months and years to the Greek debt has eroded investor and consumer confidence and provoked increased volatility in currency markets. Since March 2010 there is an ongoing sense that there will be more disclosures and more problems.
The European Union and the Eurozone are not collapsing , nor unraveling. But it may transform back into a two tier Europe, the “geometrie variable” configuration set out by former Prime Minister Balladur in the 1990s, between the French-German core and stronger “northern” economies, weaker “southern” economies and the non Euro members.
European Union , as well as Swiss, financial sectors despite the shock of the last two years still remain global powerhouses with nearly a quarter of their profits from Asian and US operations. However the relationship between the state and the banks will have to be clarified and codified for future crisis. The days of opaque incestuous management, limited disclosure , mere lip service to transparency and disdain for full accountability may have finally come to a close. Financial reforms will occur on the legislative and political level , but more profoundly across Europe reform will have to occur within the internal organizations of major institutions. This may prove more wrenching as it has to
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attack historic cultural and country specific traditions , but in order to meet the next crisis it will have to take place.
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