Credit Squeeze to Intensify Across Europe As Rising Defaults Force Banks on a Diet

Michelle Remo, “Big 4″ observer
February 29, 2012 /

Pressure to consolidate, concern about securities trading, and the impact of capital and liquidity rules drive a very conservative approach by banks

According to Ernst & Young’s European Banking Barometer, which is released today, banks are avoiding big restructuring and business development projects and instead are focusing on housekeeping as pressures from the wider economy deepen and new regulation further hits balance sheets. Lending to all major industries will be hit, and banks predict rising defaults across all major sectors in Europe.

The banking barometer is a survey of 500 bankers across Europe; 50 each from Austria, Belgium, France, Germany, Italy, the Netherlands, the Nordics, Poland, Spain and the UK.

Marcel Van Loo, Europe, Middle East, India and Africa Leader for Banking and Capital Markets, commented: “Banks are effectively being forced on a diet – on the one hand they are being asked to hold more capital but on the other they are facing ongoing unresolved macro-economic instability which is now hitting their loan books, with a significantly increased risk of default across all major industries.

“It is true that increased customer deposits and intervention by the ECB have a clear positive impact on the banks’ liquidity; however increased capital requirements will prevent lending policies being relaxed. Banks are concerned about the impact this will have on the real economy – they are not currently in a position to be the drivers of the recovery.”

Defaults predicted to increase across the board

European banks expect an increase in the level of defaults across the board. The banking industry is most concerned about default in the construction sector, with almost half of banks (46%) expecting an increase in defaults from that sector.

Construction is followed by automotive, corporate real estate, services and transport sectors, in which around 38% of banks expect there to be an increase in defaults. Chemicals and pharmaceuticals and utilities are rated the healthiest industries but banks across Europe still expect the risk of default to rise.

Events are forcing banks to tighten their lending policies across all industries and there is a strong correlation between the sectors in which they expect increased defaults and those in which lending policies will be tightened, including real estate, construction, services, transport and infrastructure.

Lending on corporate real estate and construction will be hit hardest with 40% of banks expecting their policies to tighten. However, this is not uniform across Europe – 61% of banks in Poland and the Nordics expect lending to be more restrictive for corporate real estate, whereas around 75% of banks in Germany and the UK do not expect their policies to tighten.

Steven Lewis, Director in Ernst & Young’s Global Banking and Capital Markets team, commented: “Lending on corporate real estate has been a long-anticipated pressure point for banks, but the rate of impact has not been uniform across Europe. We can now see real evidence of the more prudent lending policies that have been adopted in markets such as the UK and Germany over the last two years, now being adopted by banks across Europe.”

Increase in cost of capital to be passed onto the real economy
Forty-four percent of banks in Europe expect Basel III to reduce lending to the real economy, concerns are particularly high in Austria (74%) and Germany (63%).

Sixty-seven percent of banks expect Basel III to increase the cost of credit for clients, with 94% Austrian banks, 85% of Nordic banks and 80% of Polish banks expecting the cost of credit to increase for their clients. However, banks do not expect to be able to pass the whole cost on as 45% of banks also expect Basel III to hit bank profitability.

Steven said: “Although 41% of banks expect deposits to increase, the combination of macro-economic uncertainty, continued pressure on wholesale funding and capital and liquidity constraints, mean that overall lending will decrease and the cost of credit will increase for both banks and the companies or individuals they lend to.”

Big plans left on the sidelines as banks prioritize housekeeping
Risk management, Basel III and curbing non-essential expenditure are the top three priorities for banks this year, followed by cutting overall costs and streamlining processes. Off-shoring, and developing new markets are at the bottom of banks’ priorities.

Big changes such as re-assessing the product line up, restructuring or establishing new business sectors, asset disposals and new remuneration systems are ranked as middling priorities.

Steven said: “Banks across Europe have consistently ranked costs, risk and regulation as their top priorities of the moment. This is only to be expected given the continuing challenges in the Eurozone – banks across all markets are focused on solving problems and reacting to events rather than proactively developing strategic growth projects.”

But pressure to consolidate is looming

Well over half of banks surveyed expect pressure to consolidate to increase in the next six months, other than in the UK, where just 24% of banks expect pressure to consolidate. Austrian and Spanish banks feel this most acutely with around 75% of them expecting increasing pressure to consolidate in the next six months.

In the medium to long term German banks expect the greatest pressure to consolidate, with 74% of them anticipating significant pressure to consolidate.

Steven commented: “In those markets where the banking industry remains fairly fragmented, pressure to consolidate will undoubtedly be high over the next six months as small players will find it difficult to operate in this increasingly capital intensive world unless they occupy a particular niche. As further evidence of these pressures, a quarter of banks across the region also expect asset sales to increase in the next six months.”

Securities trading is the business area banks are most worried about
Banks are most concerned about the future of their securities trading business, with 30% of banks expecting the outlook to be negative for this sector.

“It is no surprise that, facing multiple regulatory changes and the threat of a Financial Transaction Tax, banks across Europe are worried about their securities businesses. As profits in this sector are squeezed, scale and efficiency will become even more important,” added Steven.

European banking market divided on prospects for 2012

Austrian, German and Spanish banks are the most concerned in Europe about their current performance and the most pessimistic about the outlook over the first half of 2012. Only banks in Poland were unanimously positive about their current performance and are the most optimistic about their prospects in H1 2012.

Marcel commented: “It is the macro-economic factors that are unsettling banks in Europe the most. Those countries in which banks are least optimistic about future performance are the countries where banks are facing the greatest pressure to consolidate, where there are worries about the impact of new regulation and where concern is highest about the impact of a sovereign default.

“The areas which they have more control over, such as lending policies, defaults and headcount appear to have had little impact on overall confidence ratings.”


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