Banks: Europe’s banks have not done enough to get their balance sheets into shape
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Banks: Europe’s banks have not done enough to get their balance sheets into shape

UBS credit analysts point out that banks in the eurozone have deleveraged far less aggressively than lenders in the other two most troubled jurisdictions in the financial crisis, the US and the UK, having already been among the most leveraged and wholesale dependent going into it. This has left them poorly positioned to deal with the large macroeconomic shocks that might now be at hand.

Investors struggle to read banks’ financials and don’t trust them. Big doubts have grown up in the past few months over inputs to the calculations by which some banks seem to have produced favourably low ratios of risk-weighted assets to total assets.

Stress is already evident in the funding markets. Money-market funds in the US have been cutting their holdings of European banks’ short-term dollar debt. A build-up of bank deposits at the ECB suggests banks are becoming less willing to lend to each other and more inclined to hoard cash and deposit it with the central bank.

In August, UBS analysts tracked the premium above collateralized repo costs that European banks charged each other for three-month unsecured funding and found it had risen over the summer from around 25bp to 70bp. That’s nowhere near as bad as the 196bp peak during the Lehman bankruptcy but way above the meagre 4bp premium that prevailed in the years leading up to mid 2007.

Secured versus unsecured
Eur bank funding, three month spread 
Source: UBS, Bloomberg 

When any European sovereign comes into the eye of the financial markets storm, its banks cannot borrow in the wholesale term capital markets.

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