Measures implemented by governments in Eurozone have one common denominator: Massive increase in debt from governments and the private sectorLoans send incentive packages from Germany to Spain. The goal is to give firms and families some leverage to overcome the difficult months of imprisonment and allow the economy to recover significantly in the third and fourth quarter. This bet on a speedy recovery could put the troubled European banking sector in a difficult situation.
Banks in Europe are in much better condition than in 2008, but this does not mean that they are strong and ready to take billions of loans with higher risk. European banks have reduced their non-performing loans, but according to the European Central Bank, this figure is still high – 3.3% of total assets. Financial institutions will also face low net profit over the next two years due to negative rates and very weak capital returns.
The two most important measures that governments have used in this crisis are large enterprise loans, partially guaranteed by member states, and substantial unemployment subsidy schemes to reduce the burden of unemployment. According to Eurostat and Bankia Research, nearly 40 million workers in large European countries work on a subsidized scheme for the unemployed. Loans, which account for up to 6% of the Eurozone GDP, were provided to enable enterprises to cope with the crisis. So, what happens if the recovery is weak and uneven, and growth rates in the third and fourth quarters are disappointing, I believe, to happen? Firstly, the growth of non-performing loans can raise the total figure to 6% of total assets in the banking sector or to 1.2 trillion euros. Secondly, up to 20% of subsidized unemployed people are likely to join total unemployment, which can significantly increase the risk in mortgage and personal loans.
Banks may face tsunami due to the collision of three factors:
growth of non-performing loans,
deflationary pressure from a prolonged crisis and,
The central bank holds negative rates that destroy bank returns.
We estimate the net debt growth to EBITDA of the largest Stoxx 600 corporations by 3 times compared with the current 1.8x. It means that banks may face a wall of delinquency and weakening solvency and liquidity in the vast majority of their assets (loans), since deflationary pressures are hitting the economy, economic growth is weakening, and the central bank is taking even more aggressive, but useless liquidity measures and damaging rate cuts.
This combination of three problems at the same time can create the risk of a financial crisis caused by the massive use of bank balance sheets to solve the problem of saving all possible sectors. This can undo all the improvements in the balance sheet of financial institutions, achieved slowly and painfully over the past decade, and destroy it in a few months.
Weakening the balance sheet of banks and concealing greater risk at lower rates in their balance sheets can be extremely dangerous policies in the long run. Governments were pushing banks to give loans to businesses and families with very difficult financial conditions, and this could return as a boomerang and hit the European economy, where, according to the ECB, 80% of the real economy is financed by the banking sector.
Governments should take more reasonable measures and solve the problem of crisis 19 by lowering taxes and subsidies, and not through significant loans, even if they are partially guaranteed by the states. If the sovereign debt crisis starts to grow again, there will be a fourth risk that could harm banks and finance the real economy.
The banks’ reaction to this crisis was positive, but perhaps too early and clear, they risk too much at too low rates. So far, financial institutions have been cautious and have made large reserves to strengthen the balance sheet. However, these provisions may have to be doubled in the following quarters.
Taking measures to prevent the onset of a financial crisis based on these extreme measures will be crucial to prevent a larger problem in 2021–2022.