The Plight Of Europe's Banking Sector, Its €650 Billion State Guarantee, And The "Urgent Need" To Recapitalize

Tyler Durden's picture

A month ago we quantified that just the overt European bank undercapitalization (excluding spillover effects from counterparty liability and derivative exposure) resulting from non-performing loans, is a staggering €500 billion. These NPLs "reduce the capacity of banks to lend, hindering the monetary policy transmission mechanism. Bad debts consume capital and make banks more risk averse, especially with respect to lending to higher risk borrowers such as SMEs. With Italy (NPLs 13.4%) now following the same dismal trajectory of Spain's bad debts, the situation is rapidly escalating (at an average of around 2.5% increase per year)." The implied conclusion is that Europe has kicked the can far longer than it should, and as a result its banks have become zombie shell with unprecedented accrued losses, supported explicitly by their various governments, and thus, by the ECB, which is now in the business of preventing sovereign failure (despite its repeated promises otherwise).

And since the topic of quantifying how big the sovereign assistance to assorted banks - both in Europe and the US (which Bloomberg calculated at $83 billion per year) - has become a daily talking point, we are happy to read that Harald Benink and Harry Huizinga have reached the same conclusion as us in their VOX analysis, and further have shown that in Europe the implicit banking sector guarantee by the state is a whopping €650 billion.

Until now, Europe’s banking sector has been kept afloat by implicit state guarantees of virtually all liabilities. Michiel Bijlsma and Remco Mocking (2013) of the CPB Netherlands Bureau for Economic Policy Analysis find that in 2012 these guarantees provided banks in Europe with an annual average funding advantage amounting to 0.3% of total assets. They base this estimate on a comparison of banks’ diverging credit ratings in scenarios with and without government bailout support. An annual funding advantage of 0.3% of assets can be capitalised to be equivalent to 2% of total assets, on the assumption of a discount rate of 15% commensurate with banks’ uncertain earnings prospects. Given total banking assets of €33 trillion in the Eurozone, we are talking about an implicit guarantee of about €650 billion.

Benink and Huizinga go so far as making the call for an urgent recapitalization of Europe's ban:

Europe has postponed the recapitalisation of its banking sector for far too long. And, without such a recapitalisation, the danger is that economic stagnation will continue for a long period, thereby putting Europe on a course towards Japanese-style inertia and the proliferation of zombie banks.

So while the recent advent of the Japanese Carry Trade has been a useful distraction to the insolvency of Europe's banking sector, the underlying reality, as confirmed by the build up of massive unrecognized losses, is only getting worse, and the market is well aware of this:

Banks are already saddled with ample unrecognised losses on their assets, estimated by many observers to be at least several hundreds of billions of euros and mirrored by low share price valuations, and an additional loss of their present funding advantage will be crippling.


On average, the market-to-book value of European banks now is about 0.50 (see Figure 1). This indicates that accountants’ estimates of bank capital are far too rosy, and that banks have substantial hidden losses on their books. In a recent speech Klaas Knot (2013), Dutch central bank president and European Central Bank governing council member, noted that restoration of banks’ balance sheets is a crucial requirement for economic recovery. To facilitate this process, Mr Knot states, it is essential to create transparency about losses in the banking sector and to have an orderly resolution of lossmaking assets. Without this, banks will remain restrictive in making new loans. Mr Knot adds that the planned European banking union offers an appropriate opportunity for speeding up the resolution process.


Furthermore, since European banks are unable to grow into their balance sheets using profits (for the simple reason that stripping away accounting gimmicks the vast majority of European banks are hardly profitable, if outright unprofitable), it will mean that the Cyprus bank resolution scheme will soon be coming to a seemingly healthy European bank near you.

The plight of Europe’s banks worsened considerably when Jeroen Dijsselbloem (2013), Dutch finance minister and Eurogroup president, stated that the approach taken in Cyprus of resolving failed institutions without using taxpayer money would in future preferably apply throughout the Eurozone. Consistent with this, Wolfgang Schäuble (2013), German finance minister, recently stated his desire ‘to ensure that enrolling taxpayers to rescue banks becomes the exception rather than the rule’, and that to achieve this ‘we need credible EU bail-in rules as soon as possible’.


Financial markets understood Mr Dijsselbloem’s message, as shown by a subsequent decline in the share prices of many institutions. Very low bank valuations imply that they will find it very difficult to recapitalise themselves by issuing equity or debt that is convertible into shares – in part because share issuance would further dilute the value of implicit state guarantees. Low share prices, in effect, imply that banks can raise only limited capital by issuing new shares, and that they may need to accept reduced issuance prices. Very few large European banks are raising capital by issuing new shares, no doubt as they realise that this is not in the interest of current shareholders. As exceptions, Deutsche Bank raised almost €3bn in April, while Commerzbank announced plans to raise €2.5bn through a heavily discounted rights issue in May.

The VOX authors' conclusion - the time to stop kicking the can has arrived:

Time to recognise losses


It is now urgent to start recognising losses on balance sheets to avoid a proliferation of Japanese-style zombie banks in Europe. To facilitate this, we advocate conducting a new and thorough stress test soon, similar to the one administered by US supervisory authorities in 2009. Of course, the financial position of most governments in Europe is much worse than that of the US in 2009. So Europe needs to take a path towards recapitalisation that in some respects differs from the earlier US approach.

  • First, a credible stress test should assess the losses hidden on the balance sheet for each bank, as well as the likely cost of the removal of implicit guarantees of all liabilities.

This will result in an estimated capital shortage, taking into account capital levels as required by international bank supervisors. Recently, the Financial Services Authority (2013) conducted a stress test of UK banks, resulting in a necessary downward adjustment of reported regulatory capital of about £50 billion, and a resulting regulatory capital shortfall of £25 billion. The estimated capital shortfall of £25 billion is likely to be a low estimate, as it is by and large predicated on the continuation of implicit state guarantees in the UK. At any rate, thorough stress tests in other European countries are likely to reveal sizeable capital shortfalls as well.

  • Second, supervisors need to assess whether the capital shortfall can be financed by international capital markets and/or national governments.

In case the required amounts are too high, the bank immediately must be entered into a resolution and restructuring process imposing some losses on unsecured creditors (the Cyprus model).


The legal basis for this resolution and restructuring would be an intervention law, which some European countries may need to enact through emergency legislation. Most banks in Europe, in contrast with their Cyprus counterparts, have significant financing by bond holders and can be recapitalised by imposing losses on holders of subordinated and common debt without infringing on savings deposits.

  • Third, in the event that capital shortfalls are relatively small, supervisors could instead implement the US model.

This would mean that banks are given a limited period of time to issue equity on international capital markets, after which national governments step in to provide the remainder of the equity shortfall.

What is coming next is the New Normal's new favorite phrase: share sacrifice. Supposedly by unsecured creditors at first:

The way in which Europe recapitalises its problem banks now has a direct impact on the design of the future European banking union. If many banks are recapitalised by imposing losses on unsecured creditors, such as holders of subordinated and common debt, this is likely to be reflected in the design of the single resolution mechanism that will determine the extent to which bail-ins are mainstreamed in future bank resolutions in the EU.

Although coupled with the recent push to sequester large bank deposits, in part or in whole, and amounting to as much as $32 trillion globally under the guise of punishing tax evasion, one can be certain that secured debt holders, not to mention bank deposits, will also be impaired. It also means that when the most recent coming of the Japanese carry trade finally unwinds, and judging by the recent plunge in the Nikkei and surge in the JPY, its days may be numbered, look for the knock off effects in the European financial and sovereign bond market to usher in what may be the perfect storm of both Japan and Europe suddenly going from stable to highly combustible at the same time. Which will once again leave Ben Bernanke as the only central bank with any gunpowder left to preserve and restore stability in the "developed" world.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
GVB's picture

Banks rule nations. Sad, sad, sad.

Gene Parmesan's picture

Banks, central and otherwise, have already started trying to rule their depositors as well, exacting what are euphemistically called "haircuts." Depositors need to realize that they have other options when it comes to financial residency.

philipat's picture

Great idea for a new product: Mattresses with concealed compartments on the underside.

bank guy in Brussels's picture

That is a funny article

Yves Smith there is arguing that it is quite all right for the European Central Bank to buy bonds of countries falling apart like Spain or Greece

Because, you see, there is interest paid on the bonds by Greece or Spain, and those interest payments get paid to the ECB which bought the Greek or Spanish bonds ...

And that interest is 'profit' ... above all for Germany, that is the biggest ECB shareholder ...

And of course all those bonds of Spain or Greece with populations heading to 30 % unemployment because of the euro, that's all money good for a while

And Yves says it's no problem if Greece or Spain defaults, the bonds just disappear into a central bank black hole and the worst that happens is the interest payments stop.

But till then it's profit for governments ! Have all central banks BUY BONDS OF COUNTRIES GOING DOWN THE DRAIN ! Terrific idea there, Mr Yves Smith

Non Passaran's picture

She's a socialist fanatic as far as I can tell. I can't stand that blog.

One out of 50 posts there is OK (usually those about civil liberties and state crime).

falak pema's picture

She knows more about how the system works than most of the libertarians here.

disabledvet's picture

Government cannot "fail" like a business...i agree. "Greece" is still around. Obviously so is Spain. What BGfrom B makes sense...but to ignore the existence of Spain is more than a little ridiculous. This isn't being put forth because it should be but because it has to be. And as is stated..sure, this helps Germany...but it's not really helping the German Banks. This is a CAPITAL FLOW from the South into the Center. For Banking to prosper there needs to be a commensurate increase in trade flows across the border...something that has not happened since 2008...and then obviously a more healthy lending environment...something that still does not exist...really in Europe as a whole. Simply put this is going to be a long recovery process. And with all the Esoterica that is presented "the devil in the details" problem has yet to emerge as well. i'm sure there will be a bunch of micro data that causes probelms that emerges as well.

PiratePawpaw's picture

Uh...isnt that about how the investors in a ponzi scheme "profit"? until they dont.

aaaaaaaaaaaand its gone.

newworldorder's picture

Thanks for the article cross-post.

RE: post - If as stated Central Banks are freed from all responsibilities other than "price stability" then we have moved into a world were International GAAP standards do not apply to Central Banks. As such they are free to fund direct governments monetizetion, with no government being forced into bankrurptsy. Central banks and governments can then fund any and all of their liabilites AT WILL.

There are many questions here, but the most important is; How is price stability maintained when a commodity necessary for human life to exist, is measured against the application of unlimited money printing that a central bank or sovereign is allowed to engage in?


falak pema's picture

I'd like to hear the TD's commenting on this analysis.

I am not a banker. So I don't have a clear idea of how KEY CBs accumulated debt should be assessed, and what the risk on their downside is. I know from experience that if you are MINOR central bank of Argentina you don't get the same treatment in the market as central bank of USA. But then you are not part of Oligarchy and that is final verdict like Pope's excommunication was yesterday. You don't count politically, period.

That said, the problem today is private banking shitholia worldwide, avowed before markets as  on B/S, or  unavowed and off B/S for derivatives, the latter lost in  OTC counter party scams, rehypothecated like a harem woman who gets gang banged but whose lord does not feel his life is at stake, as he has made her available to pay for his crimes, aka Corzine the great.

THis CB liability and its impact on Oligarchy scam via private banks is central to the current problem. If the CBs in the context of floating rate currencies have ONLY ONE obligation, keeping prices at bay to allow private scam ad nauseum behind the tinsel curtain, we are not out of this tunnel.

THis could go on for decades as these OLigarchs hold all the cards, and the DOOMERS and gloomers just hope in terms of wrong financial logic that the TBTF  power structures are at unsustainable risk; but in reality this squid/FED cabal can laff at their obtuse rationale. There is no accountability for these oligarchs which leads to inevitable financial armageddon and will bring the house of cards down.

As the CBs in power  are not accountable in terms of losses and debts. Period. Its a sink hole of incalculable dimensions if you be first reserve or even second reserve currency! 

Your PM fall back, in contrarian logic of first world investors , has no validity. 

THE ONLY thing that can bring this construct down, in the linch pin of Oil oligarchy feeding the debt system with REAL wealth, is the disappearance of cheap OIL; the silk route of modern economic power. If that Saud connection goes down the shute this house of CB cabal goes down in real commodity terms.

We will then be in the torn curtain world of fiat bonfire of illusions; not before. What the USSR ate as humble pie yesterday the USa will then have to regurgitate tomorrow. 

Keep your eyes glued to Syria/Iran scenario. The mid east is the nexus of this Pax Americana corrupt construct.

ebworthen's picture

Professor De Grauwe says:  "Central banks cannot default".

ROFLMAO!  He is obviously not a History Professor.

BlueStreet's picture

Recapitalize with more debt, the train rolls on. 

TeamDepends's picture

In Debt We Trust-  That's what it says under the capstone on the new Bernanke Bux.

Midasking's picture

Deutsche Bank Horribly Undercapitalized

Carpathia's picture

Shared sacrifice.  Heads I win, Tails you lose.

JJ McApe's picture

the big leviathan is hungry for moar cash

next: feeding the beast with savings accounts

Atomizer's picture

The first half of the decade marked primarily by world geopolitical dislocation

- Except book "World crisis - The Path to the World Afterwards" by Franck BIancheri, Director of Studies at LEAP and GEAB coordinator -05/02/2011

bank guy in Brussels's picture

Hopium for large depositors in Europe's banks in the article above -

« Most banks in Europe, in contrast with their Cyprus counterparts, have significant financing by bond holders and can be recapitalised by imposing losses on holders of subordinated and common debt without infringing on savings deposits. »

Makes me think of the February 2013 promise by the Central Bank of Cyprus that deposit confiscations were impossible ...

About six weeks before they happened

Meme Iamfurst's picture



lets not ever forget that these European banks with branches in America, walk right up to the Federal Reserve window and get free money ( just like the American banks do).  Once again, a legacy of 2008 George Bush that this administration has not stopped or uttered one damn word about.

newworldorder's picture

Leaving politics aside; The FED is the defacto Central bank to the World. Through BIS, IMF and US Branch Banking of Foreign Banks it is able to funnel whaterver funds are needed (through various means including sWAPS,) to foreign commercial as well as Central Banks.

This is the reality of world banking today. Why are so many educated and well informed people, refuse to see this reality?

Atomizer's picture

Bravo, another one understands the Mickey Mouse monetary illusion.

You just earned 1 million Disney credits to be first on any amusement park ride.


GCT's picture

+1 Newworld.  Currently the Fed is the root of it all.  However the BRICS and other countries are trying to get out of the dollar for oil!

The Swedish Chef's picture

I´m not saying confiscation will not happen but the basic premise is true. In a zero (or close enough) interest world, no one saves in accounts. Bonds are sold to large investors as MBS´s are supposedly safe. In Sweden, all mortgages are financed this way.

timbo_em's picture

On paper I do agree with the authors' conclusion. But since the first step would be a stresstest, a credible one, we all know how this is going to end because there have been numerous streetests since Lehman and all were labelled credible by TPTB.

Hell, according to the 2011 EBA stresstest Dexia was one of the most solid banks in the EU. Oh and in some other news a planned stresstest on European banks has just been cancelled.

RSloane's picture

There will be no stress tests of any worth on any level because the results would not be publishable, let alone support current propaganda.

Jason T's picture

Hence "King Dollar" ..for now.  

Atomizer's picture

Quite the opposite Jason. Imagine spinning six dishes from separate poles and juggling a chainsaw. Your cell phone rings for an amber alert notice. How do you think the show will end?

Just another revolving door of new crisis actors stepping up to the plate. Each one has a new spin to solve problems under the pandering of reforms.

We'll Kill the Dollar

Handful of Dust's picture
5 States Where Foreclosure Starts Are Surging


(In case you're wondering, they are Maryland, Conn., Hawaii, New Jersey and Arkansas.)


This will help clear the massive 9 year, 13 million oversupply of inventory/houses. Also helps correct the Bubble prices ... "What can appropriately be called a glut of foreclosed homes hitting the market in New Jersey has negatively affected the growth of home prices. " the article says.


It's a start anyway.

Proofreder's picture

Somewhat OT (Topic is Europe, yes?)

Greece has just experienced a 6.2 magnitude earthquake about 35 miles South of Pirgos, Greece, CRETE.

Pretty strong for that part of the world.

Shake, Rattle, Rock 'n Roll.

q99x2's picture

Hire Paulson and Summers to get the ECB to cut a $700 billion check no problem.

Or they'll be marshall law in the streets and the ATMs will stop working.

Schmuck Raker's picture

I just read a very good essay,

"WHEN MEN BECOME RATS(Longterm effect of inflationary monetary policy on society)", by Linus Huber

It was posted a few days ago in the comments section of Michael Pettis' latest article:How much investment is optimal?<link

Give it a read. I don't think anyone here will be disappointed.

Re-post, perhaps this is a more appropriate thread.

malek's picture

 And, without such a recapitalisation, the danger is that [...]

But, but... I thought with the legalese stipulation of "bail-ins", all needed recapitalizations had been done?  (on the back of the depositors)

A_S's picture

please label your axes

CHX's picture

Recognize the losses? Dream on.

ebworthen's picture

Privatized gains / Socialized losses.

The banker prescription continues to be given to the sick patient, making the patient sicker.

If the prescription is stopped, and the patient gets better, the "doctor" is discredited and stops making money hand over fist.

The blood-letting with lancet, the alcohol snake oil elixirs, and the tincture of laudanum under the tongue will continue until the patient dies - and then it will be "God's will" and something "no one could have prevented".

Sudden Debt's picture

let the bail in games commence!!

Let's see how people will react to the bankers when they all lose money.
I don't think bankers will walk the streets without security guards from than on...

skydrake's picture

Until now, no one of "broke" European bank has really failed leaving anything unpaid, unlike the (American) Lehman Brothers.

Mark Urbo's picture

Which is exactly the problem.  Failed entities need to fail.

skydrake's picture

But the European financial system can easily survive to a collapse of a failed entity, not a collapse of dozens of failed entities, especially these big banks, so are there other solutions than make artificially survive them? 

RaceToTheBottom's picture

Does this mean that the US dollar stays the cleanest of the dirty shirts?  And therefore gold continually plays second fiddle?  Or do people finally get pissed off and break the dollar/gold rules?