Country risk: The safest and riskiest European banking sectors

Jeremy Weltman
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Bank stability has deteriorated this year in 15 European countries, improved in 13 and is unchanged for nine, according to Euromoney Country Risk

Five years on from the first eruptions of the global financial crisis – and as policymakers ponder the role of a new European banking union and financial system regulator – bank stability remains a key concern for risk managers, not only in the eurozone but right across Europe.

A mid-year annual assessment by the European Banking Authority, Report on risks and vulnerabilities of the European banking system 2012, notes: “The situation remains extremely fragile with increasing uncertainty on asset quality, funding capacity and concerns over the possibility of extreme events. Banks and supervisors are considering and putting in place relevant emergency actions as a rapid deterioration of events could lead to further significant change in the banking landscape.”

However, based on the latest, November, bank-stability scores from Euromoney’s Country Risk Survey (one of 15 economic, political and structural risk factors constituting the overall risk score), considerable variation exists in perceptions of bank stability. Some countries are still showing worrisome fault lines, while others are becoming more stable, according to economists and country-risk experts.

The indicator seeks to assess banking system strength, where 10 would indicate a perfectly functioning system with all possible exposures comfortably covered and zero a complete breakdown in the banking system. 

Wide variation in bank risk

Presently, 4.4 points separate the top 10 countries from the worst 10 when comparing the average bank stability scores between each group. Norway, with its comparatively low-risk banking sector, commands a score of 8.6 out of 10, and remains just above the other four countries perceived to be similarly safe (with scores of 8 or above). They are Finland, Switzerland, Sweden and Luxembourg, which head a list of European countries in ECR’s survey.
Norway’s banks might be still vulnerable, perhaps to a bursting of the credit boom, but were less exposed than those in some other European countries to syndicated financial products during the global financial crisis, and remain to this day well regulated and profitable as a result of a strong economy and risk-averse management practices.

The Norwegian bank-stability indicator is 6.1 points better than either Bosnia-Herzegovina’s or Montenegro’s – the two worst performers in the European segment of ECR’s survey, on scores of just 2.5 out of 10 each. Their underdeveloped financial systems might be as much to blame as credit-supply constraints and contagion fears.

Similar arguments of robustness can be made about Swiss, Swedish and Finnish banks, and even those in Luxembourg, despite the latter country being at the heart of the eurozone.

Wealthy private banks and low sovereign exposures help to minimize the Grand Duchy’s risks, which mostly stem from cross-border ownership structures. The failures of Icelandic bank subsidiaries and the problems incurred by Dexia and Fortis highlighted the vulnerabilities in Luxembourg-based banking during the crisis, but a resilient housing market and only moderate household debts minimized the reverberations in domestic credit markets.

And note, too, the comparative strengths of the banking sectors in the Czech Republic, Slovakia and Poland. These countries are vulnerable to a deepening of the eurozone crisis; their economies are unavoidably contracting as a result. However, they have also corrected excessive fiscal vulnerabilities and current-account imbalances by implementing tough austerity programmes more rapidly than in the distressed eurozone sovereigns.

Miroslav Frayer, an economist at Komercni Banka, says: “The situation in the banking sectors of the Czech Republic and Slovakia is much better than in many of the core eurozone countries, largely due to low loan-to-deposit ratios, meaning the banks in these countries are not dependent on external financing as they have enough internal sources for their lending activities.” 

How has bank-stability risk altered?

However, while current scores are extremely useful for assessing the relative strengths of the region’s banking sectors, they say little about changing risk perceptions, which can only be obtained from historical comparisons.

Looking first at the trend so far last year, three distinct groups emerge: a total of 13 European countries registered improved scores in 2012, 15 have deteriorated and nine show no change.

Among the risers – surprisingly perhaps – are Portugal and Italy, but only a modest improvement is evident. With the countries on scores of 4.3 and 5.5, respectively, risk experts still harbour deep-seated concerns about their financial-system health. Albania also stands out. Its bank-stability score had fallen to just 3.6 out of 10 by January – highlighting links to Greece as well as the spread of banking-sector contagion from west to east – but had recovered to 4.6 by the end of last year.

Careful interpretation

Albania’s bounce might be partly linked to a $30 billion central and southeastern Europe action plan, agreed jointly by the European Investment Bank, the European Bank for Reconstruction and Development and the World Bank, to underpin credit expansion. That might also help to explain the improvements in bank-stability scores for Latvia, Lithuania and Croatia, three other improvers since January 2012 – and ultimately the resilience of the Czech Republic, Slovakia and Poland.