European banking risk falls by half to spring 2008 levels – HEC Lausanne study

By:
Sid Verma
Published on:

Banking-sector risk in Europe has almost halved since its peak in the summer of 2012, thanks to a wave of deleveraging, according to the latest projections from a systemic risk index, Euromoney can reveal. However, banking-sector leverage in France and Italy remains a source of systemic risk, while Greece and Ukraine are bright spots, according to the index.

The amount European governments would need to inject into the region’s banking system in the event of a financial crisis – defined as a 40% semi-annualized fall in global stock markets – dropped from a 2012 peak of €1.5 trillion to €800 billion, according to a European systemic risk (SRisk) index from the Centre of Risk Management at Lausanne (CRML).

Compared with the summer of 2012, the dynamic index reveals European policymakers face an easier task to bring banks’ capitalization back to a prudential ratio of 5.5% in the event of a systemic financial crisis. European banking systemic risk levels are back to spring 2008 levels.

Michael Rockinger of CRML says: “This fall results from the decline in SRisk within all countries. For some countries the decline is faster than for others.”

In part due to the large volume of off-balance liabilities and weak growth, France remains the most systemically risky country and would need almost €226 billion to recapitalize the country’s banks in the event of a crisis, though this liability is 27% off its peak. The country has the second-largest market capitalization of banks in Europe.

Italy also remains a source of systemic risk with the improvement in the country’s lenders’ leverage ratios underperforming counterparts, against the backdrop of banks’ large sovereign exposures and fears over lenders’ imbalanced business models.

The country’s SRisk has fallen by a relatively modest 14.7% during past year to €74 billion, with UniCredit representing the largest exposure at €25 billion, followed by Intesa Sanpaolo (€13 billion) and Monte dei Paschi di Siena (€9.6 billion).

Rockinger says: “The reason why banks in France and Italy could not reduce their SRisk as fast as others, say Germany or the UK, has probably to do with the general economic environment.

“In blooming economies, banks can restructure with greater ease compared with depressed economies, where the default risk of companies and household is high.”

The UK, with the region’s largest banking sector by market cap, has a SRisk score of €170 billion, equivalent to a 32% decrease during the past nine months, and boasts the lowest leverage ratio among the large countries.

Germany’s SRisk follows with €106 billion, a 31% decrease during past nine months, and €67 billion in Italy, €48 billion in Switzerland and €50 billion in the Netherlands.

By contrast, Ukraine’s banking sector poses no systemic risk, a modest quantum of solace to policymakers, as the currency falls to historic lows.

Meanwhile, underscoring the disruptive wave of deleveraging in recent years, SRisk in Greece has fallen 13.4% during the past year to €12 billion, with Piraeus Bank and Alpha Bank judged to have zero SRisk. The largest SRisk is found at Eurobank Ergasias with €1.9 billion.

Using methodology developed in collaboration with the influential New York University Stern’s Volatility Institute, run by NYU professor Leonard Stern and Nobel laureate Robert Engle, the index gauges large European banks’ systemic risk by measuring size, leverage and exposure to global equity market shocks.

Nevertheless, the relationship between equity declines and a given banks’ capitalization is complex and non-linear, depending on the nature of financial inter-linkages and the origin of the crisis, among other factors.

HEC Lausanne study’s findings echo the relatively sanguine views of regulators and equity analysts, who cite deleveraging as well as market and regulatory pressures to boost core tier 1 ratios and capital buffers against the trading book, among other factors, as indicative of a decline in the region’s systemic risk.

Parameters of peripheral countries





















LRMES: measures how much a firm’s value drops on average conditional on a market crash, defined as a 40% drop of world index.













Leverage: the liability side of banks consists of debt and equity. The number represented by the total value of a bank divided by equity is called leverage. The higher the leverage, the more a bank has lent and the higher its risk.