The eurozone remains ‘centre stage’ as European leaders struggle to convince markets about the latest (last week’s) plans to solve the crisis. The signs are still not convincing that the crisis is over, even though there was a surge in risk appetite that helped erase the summer losses on equities. Italy’s borrowing costs rocketed only a day after the European leaders agreed the new plan last week. At the same time, Beijing and Tokyo (and this is causing some controversy) are being asked to contribute to the overall funding package needed to address the eurozone debt mountain. Franco-German differences have continued to colour the talks and the latest ‘plan’ that emerged. Not quite the scenario that the world’s markets wanted to see for resolving the eurozone crisis.
In the developing eurozone scenario, European banks are required to meet a new 9% threshold of ‘highest quality’ bank capital by next June. Bank regulators have said that the European banking system now has a capital shortfall of E102bn ($150bn) in relation to this target (The Economist, October 15 earlier estimated that this shortfall would be bigger at E248bn). Analysts estimate, however, that the banks will only need to raise around E20bn of new capital to meet this requirement. Top lenders are seeking to reassure investors that they can meet the new capital standards by retaining profits, selling assets and reducing bank pay and bonuses. But can they meet the target through these moves alone?
If the proposed (and ambitious) moves to meet the new bank capital target are not achieved, the prospects are more bleak. The problem is that these new moves could trigger a renewed ‘credit crunch’ if banks are forced to curtail their lending even further than at present in order to meet the new capital target. The European Banking Authority (EBA) has expressly stated that it does not wish the new capital rules to trigger a reduction in bank lending, but regulators have to concede that there is no mechanism in place to stop this from happening. Goldman Sachs have estimated that up to 50 of Europe’s top 91 banks could fail the new EBA stress tests and 9% capital minimum.
With the present slowing down of the global economic recovery, the banks are again under close scrutiny. For example, many blame the banks primarily for the apparent slowing down of the UK economy during recent months. They argue that they are not providing the needed financial and other support to companies, especially smaller businesses. At the same time, though, the banks are facing an ever wider and stricter raft of regulations as fears of contagion and systemic (system-wide) risk continue to stalk markets as the eurozone crisis rumbles on.
There are many clear signs that banks are now under intensifying strains. Plunging revenues and regulatory pressures have helped lead to the UK Royal Bank of Scotland (RBS) move to cut by at least a third its controversial investment banking arm. This puts 5,000 jobs at risk and RBS is by no means alone.
The bigger banks and financial institutions in the financial City of London have already announced thousands of job losses during recent months. The City is currently downsizing and this is accelerating. The main drivers of these moves are concerns about global recovery and the eurozone crisis, both of which are reflected in reduced demand for banking business.
London as one of the world’s major financial centres also faces other threats from the European Union (EU) itself. A new proposed tax (supported strongly by Germany and France) on financial trading is likely to devastate the City; it could cost many more thousands of jobs. Although Britain has said it will veto the tax unless it is imposed worldwide, the EU appears determined to go ahead with it.
So UK bankers and the City of London are certainly under enormous pressure. There is no doubt that banking reforms and new regulations are needed in the aftermath of the 2007/2008 crisis and to help address the present eurozone problems. At the same time, too much regulation will surely make a presently bad situation even worse. At a time when the banks in particular and the financial services sector in general are needed to ‘fire up’ and help the global economy to recover, they are being increasingly constrained. This ‘firing up’ of financial services as a vital channel of productive business lending and economic growth has to be a key part of resolving the eurozone crisis.
We need the ‘banking phoenix’ to rise from the ashes of potential contagion and systemic risk. Politicians and regulators must be careful not to overdo banking regulation. Bank lending and the economic stimulus that it can unleash have to be a key part of the needed economic recovery.
Professor Ted Gardener