The European banking system is creaking in response to Brexit

These days so much of economic life revolves around the banking and finance sector. The political class tied the knot even more closely with the bailouts and supportive monetary policies that began in the UK with Northern Rock in 2007. That of course is quite a few years ago now even though it feels like yesterday. Internationally there are plenty of issues especially in places like Italy where there has been very little attempt to address the problems created by 360 billion Euros of bad loans leading to a drip drip drip of bad news. A sign of the ongoing problem was provided by the US Federal Reserve last night.

The Federal Reserve objected to the capital plans of Deutsche Bank Trust Corporation and Santander Holdings USA, Inc. because of broad and substantial weaknesses across their capital planning processes, and insufficient progress these firms have made toward correcting those weaknesses and meeting supervisory expectations.

So the United States has provided a shot across the bows for two major European banks and perhaps this is partly why Mario Draghi has started talking about “vulnerabilities” rather than “resilience”. UK readers will note that Santander has a large operation in the UK and wonder about that. I was critical of the takeover of Abbey National and other building societies back at the time. Please do not misunderstand me this is not anti-Spanish in any way and I had no issue with Santander buying assets here it was the amount of them that posed potential problems.

Deutsche Bank

My old employer is something of a goliath in the German financial system but the goliath has increasingly become a problem child. A factor here is the large derivatives book which has seen all sorts of large estimates for its size. I think the largest I have seen is US $64 trillion but care is needed here as these are a past speciality of mine and valuations depend on circumstances. If a bank writes derivatives what it does not need is extraordinary events, have we seen any of them in recent times? You get the idea….

The International Monetary Fund weighed in yesterday on the German banks in general.

However, German banks’ business models are vulnerable to low interest rates. This is because most German banks have businesses based on maturity transformation with a large number of branches and high overhead costs. Net interest income is the most important component of their profits.

Not so easy when they have so far been unwilling/unable to pass on the -0.4% deposit rate of the European Central Bank (ECB).

So far banks have proven unwilling, or even legally unable, to pass on the negative interest rates to depositors, while their assets have recently started to reprice to lower interest rates.

Then it lands its punch on Deutsche Bank.

Among the G-SIBs, Deutsche Bank appears to be the most important net contributor to systemic risks, followed by HSBC and Credit Suisse……..The relative importance of Deutsche Bank underscores the importance of risk management, intense supervision of G-SIBs and the close monitoring of their cross-border exposures, as well as rapidly completing capacity to implement the new resolution regime.

The share price has responded by falling another 3% this morning and of course this comes in addition to a stream of falls. A price of 12.32 Euros gives a year to date return of -45.7% according to Bloomberg and its market capitalisation is now a mere 16.8 billion Euros. That of course means that any share issue to strengthen capital would be expensive.


This is the other German institution that was identified as globally significant by the IMF. As it is an insurer it is subject to the critique of negative interest-rates which I express regularly on here. How do long-term business models for insurance products, pensions and annuities work with an official interest-rates of -0.4% and a 10 year German bond yield of -0.11%?

For the German insurance sector as a whole how is this one going?

guaranteed return life products playing a dominant role

Also what could go wrong here?

Some evidence of search for yield has
been emerging.

European banks

If we step back we see this from Morgan Stanley with thanks to @Fmirw

The Eurostoxx banks index still trades 20% below pre-Brexit levels. This index has halved since the start of the year.

Leverage within EU banks is high and with domestic returns on assets falling (lower growth potential), balance sheet consolidation is warranted.

The implication here is that there will be even more deleveraging. It was only a few days ago I pointed out that Oliver Blanchard who used to be chief economist at the IMF was wrong to say that phase was over.

The Italian Job

I am grateful to @lemasabachthani for pointing this out yesterday.


That is clearly a hostage to fortune as the word secure goes into my financial lexicon for these times. Meanwhile the rumours about another bailout continue except of course they are prohibited by the new bail in rules in the Euro area.  Oh and the bad bank Atlante which only a few short weeks ago had saved the Italian banks according to finance minister Padoan seems to be on the list for ch-ch-changes.


Just as a reminder this uses private money.


If you look back to my updates over the past few days you will see the considerable problems with such a plan. One of Baldricks from Blackadder I think.

The US Cavalry

There was a sub-plot to the US Federal Reserve stress test results last night as there was then a barrage of responses. If I show some you will get the idea.

JP Morgan announce share buyback of up to $10.6bln up to 2017……..Bank of America announce share buyback programme of $5bln, plans to increase quarterly dividend to $0.075………Citi announce buyback programme of up to $8.6bln, quarterly dividend of $0.16/share

I think in total it came to around US $45 billion in buybacks plus some dividend increases. A type of mini QE4 for the United States and an effort to pull away from banking troubles elsewhere.


The official view was put by Gillian Tett of the Financial Times on Newsnight on Tuesday night. The view was that the bank reforms and changes had in fact meant that the banks have survived Brexit. I was left with the thought “so far” as of course this is a situation where things are always okay until in a “surprise” they are not. Whilst UK banks are stronger in capital terms we invariably find in a real crisis that they still have too little of it. Here is the view of Bank of England Governor Mark Carney.

UK banks have raised over £130bn of capital, and now have more than £600bn of high quality liquid assets.

One other thing that Gillian pointed out what that the US banks feel they have won the war. Such proclamations are dangerous as we know the whole system is so interconnected but we do know as I have described today that there are plenty of problems in the European banking system.

Meanwhile there was this announced today. From the Guardian.

United Overseas Bank said it would “temporarily stop” issuing the loans because of heightened uncertainty following the Brexit decision.

They mean mortgages in the UK. This made me think of the Nine Elms and Battersea Power Station developments near to me which had been advertising in that geographical area. It also made me think that in Singaporean Dollars UK assets are now around 10% cheaper than they were. Good for new buyers but it may be that the fall in value for existing owners in Singaporean Dollars has worried the banks risk mangers.

As to lyrics well I guess many of you are singing along to ABBA right now.

What’s the name of the game?
Does it mean anything to you?
What’s the name of the game?
Can you feel it the way I do?


Me on TipTV Finance




18 thoughts on “The European banking system is creaking in response to Brexit

  1. Hi Shaun, a question which I added to yesterday’s blog this morning, so you may not have seen it; I’ll ask again if I may:
    What effect does Brexit have on the EFSI, you know, Draghi’s wheeze where he starts off with half-a-crown, and ends up with €1trn?

    • EFSI is owned mostly by the European Investment Bank (EIB), which in turn has subscribed capital from each of the EU countries. Subscribed capital is that amount of capital that an investor has expressed an interest for, NOT paid in, or in other words, in the case of the EIB the amount that an investor is on the hook for in the event of further funds being required.

      The UK’s subscribed capital for the European Investment Bank was about 39 billion Euro last time I looked.

      The funding of EFSI is standard fractional reserve banking which most Banks are involved in (which I have problems with). If you have problems with EFSI turning half a crown into €1 trillion then you have issues with nearly all bank’s funding everywhere, as I do.

      This is one of the many issues the clueless Leave brigade need to address. Do they want to drop this subscription or retain it? Are they legally allowed to retain it? If they withdraw what are the implications for the UK Crossrail and Metrolink developments the bank is currently funding amongst others? If they retain the subscription can UK companies qualify for further loans via the Investment Bank as a non EU member?

      There are many questions about Brexit relating to EU grants in addition to EU loans as well as, of course, trade terms with EU and EZ countries and the 60 other countries which the UK had trading terms negotiated on it’s behalf as an EU member to which no one has the answer, indeed, most haven’t even thought of the questions!

  2. to be fair Shaun, the TBTF Banks are still broke since 2008 . One day , possibly soon, someone will have to tackle the debt issue.

    And if property prices fall in London it appears the world will sneeze …….


    PS: comfy sofa and some nice popcorn – the show is a good ‘un , eh ?

    • Hi Forbin

      When I saw the UOB of Singapore announcement I could not help but think of Battersea Power Station and the Nine Elms developments near to me. Stage one of the Power Station development was supposed to have had a lot of Singapore buyers and the developers no doubt had plans for more to come and buy.

      Good news for for popcorn is that corn futures have been falling even faster than the UK Pound £. So maybe you might get a penny or two off the price.

  3. Shaun
    “UK banks have raised over £130bn of capital, and now have more than £600bn of high quality liquid assets.”

    Have” high quality liquid assets” yet entered your new lexicon?

  4. Hi Shaun
    Well done again on your continued believe that interest rates were more likely to go down rather that up.Mark Carney has almost confirmed it in his speech today.
    An OMO that could come to fruition.

  5. HI Shaun
    So “Little Britain” does seem big
    enough to rock the planetary boat.
    Presumably a 0.25% drop
    in base rate will temporarily weaken
    sterling but only until the next dose of QE
    and then we all know what will happen.

    lyrics for Gove.

    There’s room at the top they are telling you still
    But first you must learn to smile as you kill
    If you want to be like the folk’s on the hill.


    • Hi JRH

      The Bank Rate cut could be more than 0.25% as they could be silly enough to cut by 0.4% say to avoid going to 0%. As to Sterling’s prospects we see that there is an announcement effect of these things on the currency and maybe some more on the day of acting but often after it rises subsequent months.

      What song is that please?

  6. Hi Shaun, I think the major Brexit related problem for banks generally is the upwards lurch in the cost of bank funding on the capital markets, although I don’t see you mention this specifically.

    The plight of Deutsche and Italian banks has been known about for months, Brexit has simply intensified investors scrutiny of known weak banks as their funding costs increase. If Deutsche can provide assurance they don’t have much UK exposure I dare say they can ride this out for the moment, the Italian Banks are a different story. I believe Deutsche are right to assume the German Government will do “all that is necessary” if it comes to a Deutsche run regardless of EZ rules.

    Why is it always the US that has to sort everything out? Can it be that only the American divisions of Deutsche and Santander have holes in their balance sheets? Or is it that the US has much higher supervisory standards than the rest of the world?

    Already the US Government has ensured it is no longer guarantor of any US banks, unlike the UK and what loans were made to the US banks were fully repaid years ago, unlike the UK. The US also is not afraid of imposing big fines on wrongdoers and jailing the worst offenders, unlike the UK.

    The same applies for Hyundai and Volkswagen cars – were the American models the only ones with false miles per gallon claims (Hyundai) and falsified emissions claims (Volkswagen). Where is the rest of the world?

    • Hi Noo2

      I do not think that I did but it was by default confirmed this afternoon by Mark Carney is his speech.

      ” today the Bank of England is announcing that it will continue to offer Indexed Long-Term Repo operations on a weekly basis until end-September 2016. This will provide additional flexibility in the Bank’s provision of liquidity insurance over the coming months. ”

      I think that the US move was a warning shot to Europe.

      As to the cars I can only 100% agree….

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