Spain, Turkey bank risk puts cloak of fear over Europe’s investor outlook

By:
Jeremy Weltman
Published on:

While the focus has been on how Italy must resolve its banking sector problems, investors should also be keeping an eye on the risks lurking elsewhere in Europe.

Flamenco-R-600
Danse macabre: Spain’s economic growth, propped up by a tourism boom,
is now going into a spin


European Banking Authority stress tests published last week flagged up the resilience of the EU banking sector to an "adverse scenario".

The tests were performed on 51 banks from 15 EU/EEA countries representing some 70% of total bank assets, but were not without criticism.

They provide a useful guide, but the banks are no longer assessed as having passed or failed.

True underlying risks might be much larger than implied, partly because bank losses have continued to rise. The tests are not conducted on the latest data, for instance.

Euromoney’s bank stability indicator, providing a measure of opinion among risk experts, shows large falls since 2010 across Europe.

Slovenia, Italy, Greece and France are among the countries registering the largest adjustments.

However, apart from Greece, the lowest scorer Spain is one of the countries flagging high instability risk in a sector that has shrunk significantly in recent years, with deposits falling.

Spain’s bank stability score is now just 4.5 out of 10, much worse than for France, Italy or the UK:

ECR Spain slump


Clouds forming over Spain

BBVA economists taking part in Euromoney’s survey presented a balanced and detailed mid-year picture of the sector, noting the downward trend in balance-sheet liabilities, improvement in liquidity, stronger solvency and enhanced quality of capital as key positives in their latest update.

Non-performing loans (NPLs) have been steadily improving, falling below 10% of total lending, as the economy has improved.

However, complacency is a dangerous thing.

Spain’s economic growth, propped up by a tourism boom, is now slowing. The political crisis is showing little sign of resolving itself, with no government formed since the first elections were held in December or the re-run in June.

It seems likely a minority government will be formed trying to achieve agreement on a policy-by-policy basis.

Consolidated foreign claims on Spanish banks ran to $1.6 trillion at the end of the first quarter of 2016, more than double the total for Italy, according to the Bank for International Settlements (Italy has far more domestic claims).

NPLs to the construction and property sector "continue to represent some 40% of the total", BBVA’s update notes.

The fall in NPLs needs to continue, as they are higher in Spain than anywhere in the EU.

However, the problem is a deeper one.

A recent Financial Times article, quoting academic research, suggests the true capital requirement of Europe’s banks is far greater than that suggested by the stress tests.

The analysis shows a shortfall of €116.6 billion for Spain’s six listed banks, which is higher than for Germany or Italy – although the number of banks involved differs.

The authors conclude these amounts are so large they would necessitate sovereign support even if the bail-in rules were triggered to force losses on bondholders; this, at a time when the accumulation of more debt would be more than inconvenient in Madrid, to put it lightly.

Spain’s gross debt burden will top 100% of GDP this year, even without these contingencies.

Plus, the political gridlock is already raising doubts over the ability of whatever administration is eventually formed to reduce the deficit sufficiently, not least given the risk of political instability and pressure from the left to spend more on social policies, to lower Spain’s high unemployment rate.

A fiscal deficit that narrowed to 5.1% of GDP last year had been targeted to fall to 3.9% by the end of 2016, but will likely be missed, despite strong economic growth. Policymaking delays and the costs of repeated elections will see to that.

Talking Turkey

Bank risks are rising throughout Europe, but not just in the European Union.

Turkey’s bank stability score, now measuring 6.2 out of 10, is higher than Spain’s, but has fallen sharply since 2010, by 1.2 points, more than it has for Belgium, Cyprus, Croatia, Denmark, Spain or the UK.

The bank sector has seen uninterrupted assets growth in recent years, but with the loan-to-deposit ratio climbing almost 35 percentage points since 2010, with liquid assets and capital adequacy declining, according to IMF data.

Terrorist attacks undermining tourism, low oil prices and now the political turmoil enticing capital outflows are an unpleasant potpourri for Turkish banks enduring a sharp rise in overdue loans from the tourism and energy sectors as bankruptcy proceedings soar.

The banks’ capital buffers are large, but the anticipated rise in NPLs will put the banks under more strain as capital is drained.

One Turkish risk expert speaking under condition of anonymity, in view of the situation there, stated rising NPLs and a weakening economy would create problems for bank profitability and exposures compounded by more lira depreciation.

This effect will come into sharp focus early next year when tourism loan repayments are made after the main holiday season, and the economy displays more signs of a slowdown.

With Europe facing additional uncertainty from the UK’s decision to withdraw from the European Union, the risk of another bank crisis is looming, along with the contagion it would bring.

This article was originally published by ECR. To find out more, register for a free trial at Euromoney Country Risk.