The view from the banks – How much?

We believe EU/EBA pressures to raise capital ratios ahead of the June 2012 deadline, combined with dislocated funding markets, raise the risk of deleveraging across the European bank sector; depending on the ability to rely on earnings generation, this deleveraging could total between €0.5trn and €3trn, up to 10% of eurozone bank assets.


Macroeconomic impact for developed Europe

Despite a record post-war drop in euro area real GDP in 2009, concerns about a credit crunch back then did not materialise. This time, however, the failure to date of governments to provide credible backstops suggests significant risks of a substantial credit tightening, particularly in southern Europe. One potential support would be to develop the ability of euro area firms to access capital markets directly.


Macroeconomic impact for emerging markets and trade finance

European banks are the world’s most active in emerging markets, with their exposures in emerging Europe dominating their EM portfolios. Near term we expect some retrenchment, via reduced cross-border funding and asset disposals; longer term emerging Europe will need to become less reliant on cross-border lending. In addition, with large European banks accounting for one third of global trade finance, we anticipate disruptions further afield.


Banks are also sellers of sovereign debt

The treatment of European banks around the Greek PSI means that the sector is now a net seller of sovereign debt in SGIIP countries; specifically, the non trigger (to date) of the Greek sovereign CDS questions the value of such instruments, whilst the ECB’s protected status means that the more sovereign debt the ECB buys, the more banks need to incorporate higher loss severity assumptions. Finally, the current 0% risk-weighted status enjoyed by many banks for their sovereign debt holdings looks anomalous and may change.


Impact of higher sovereign yields on corporate funding costs

We estimate that higher sovereign debt spreads are increasingly being passed onto private corporates’ funding costs, on average by c60bp for each 100 basis point increase in that sovereign’s debt spread. Large corporate debt spreads add to the negative effects of bank deleveraging in these member states.


Impact on corporate defaults of tighter credit conditions

Our analysis suggests a typically strong relationship between tighter bank lending conditions and corporate default rates. Overall, our two-factor model, which includes credit conditions and current elevated funding costs, suggests a 4-6% European speculative grade corporate default rate in 2012 compared with 2% currently.

source: BarCap