The European Banking System Is in Serious Trouble
Since the Global Financial Crisis of 2008, the European Banking System has been filled with politics and uncertainty. Due to the interconnected nature of the European Banking System, fiscal problems in Greece, Italy, and other members have become economic problems for the entire European Union.
Due to a conflict between regulators and banks, the European Banking System is on the road to failure.
Extreme expansionary monetary policies from European central banks have also made it more difficult for European banks to earn profits. If incentives remain low for Europe’s banks, the European Banking System will soon be an economic experiment of the past.
Low Interest Rates are Harming Bank Operations
According to basic macroeconomics, low interest rates are normally implemented by central banks to encourage lending while decreasing uncertainty. Keynesian economists argue that these expansionary policies stimulate aggregate demand in the economy. Unfortunately, this textbook Keynesian strategy may be causing adverse effects for banks. Since some countries are implementing extreme expansionary monetary policies in the form of negative interest rates, banks are losing funds from depositors who have less incentive to save.
Europe is not the only area of the world to use unconventional monetary policies in an effort to avoid financial woes. Under a controversial economic plan spearheaded by Japanese Prime Minister Shinzo Abe, the Bank of Japan has fixed negative interest rates since the beginning of 2016. This resulted in a depreciated Yen and further economic woes for Japan. It would be speculative to predict the long-run effects of this expansionary policy, but the rest of the world should be aware that extreme measures can have heavy consequences.
According to Bloomberg, regulators from within the European Banking System may help banks compensate for losses by relaxing balance sheet rules. Some experts who specialize in Europe’s banking system believes that regulators may loosen reserve requirements for banks. Reserve requirements are applied as measures to reduce the likelihood of bank failures, so this change by regulators may seem like a conflict of interest.
Data also suggest that banks in Europe are not performing well. Deutsche Bank, one of Europe’s largest investment firms, took a major hit during the beginning of 2016. Due to shrinking capital, Deutsche Bank’s market cap decreased by 33 percent by the end of 2016’s first quarter. Barclay experienced a similar situation.
The European Banking System Spreads Adverse Economic Effects
In addition to poor economic policies, public opposition is also hurting the European Banking System. According to The Economist, the Italian banking industry is being hindered by $228 billion of bad loans. With no clear solution in sight, finance experts and economists from other nations in Europe are suggesting that their countries steer clear of Italy. The fiscal problems of Greece and Spain have also reached the international spotlight, and citizens in Germany have expressed their disapproval of a bailout for these nations. These situations are unlikely to improve in the near future, so political strife may weaken the European Banking System. This would result in increased uncertainty, and financial markets would suffer.
A Conflict of Risk Aversion and Profits
Due to their lingering wariness from the Global Financial Crisis of 2008, European regulators want to prevent bank failures and economic hardships. Meanwhile, professional bankers strive to earn profits by issuing loans, underwriting, and accepting deposits. Under the current system of European banks, these two goals are incompatible.
The current regulations in Europe mandate high reserve requirements for all member banks of the European Banking System. Since the low interest rates fixed by central banks in Europe deter depositors from banks, banks are unable to transform new deposits into assets. Professionals at some banks are already realizing that they are losing their ability to profitably fund basic commercial activities. On a more drastic note, Banco Bilbao Vizcaya Argentaria SA Chairman Francisco Gonzalez believes that the European Banking System and increased global regulation will cause over 90 percent of banks to disappear within 20 years.
Regulators may have good intentions when they fix extreme expansionary policies, but their effects on the banking industry may be increasing uncertainty in Europe’s finance sector. On the bright side, European banks are highly capitalized, so the elimination of adverse regulations could prevent a banking crisis.
Unwise regulations, political pressures, and lingering effects from the Global Financial Crisis have all contributed to the weakening of the European Banking System. Highly capitalized financial firms may be able to survive, but a united European Banking System seems destined to fail.
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