French policymakers would need to inject up to €300 billion of capital – the highest level of support in Europe – to prop up the country’s banking system during a severe global financial crisis, according to a new European systemic risk index, Euromoney can reveal.
According to systemic risk measures for European financial institutions, developed by the Centre for Risk Management at Lausanne (CRML), French regulators would need to provide €300 billion, as of mid-May, to fulfil regulatory requirements in the event of a global financial crisis, defined as a 40% semi-annualized fall in global stock markets.
Using methodology developed in collaboration with the well-known and 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.
The dynamic index, updated on a monthly basis, reveals that, as of mid-May, Crédit Agricole has the greatest risk exposure of any bank in Europe, followed by Deutsche Bank and BNP Paribas.
While two British banks feature in the top five, with Barclays and the Royal Bank of Scotland ranking fourth and fifth respectively, during the past month the UK’s systemic risk has dropped by €25 billion and Germany’s by €7 billion, driven by deleveraging.
French banks appear systemically risky according to the risk index, in part due to the growth – and upward revaluation – of trading assets and derivative exposures during the past two years, underscoring the legislative push to force French financial institutions to ring-fence speculative trading activities.
Other key findings of the risk index include:
• Austria, Portugal, Ireland, Norway, Cyprus, Luxemburg, and Russia would require between €2 billion and €10 billion if authorities were forced to provide emergency assistance during a global equity market sell-off;
• The largest percentage drops in systemic risk are for Switzerland (-13%), Spain (-13%) and UK (-11%) during the past month;
• For Cyprus, a new crash would require €4 billion compared with an end-2012 GDP of €18 billion, with no material reduction in the country’s leverage or exposure to global shocks during mid-April to mid-May;
• The leverage of the Greek banking system remains one of the highest in Europe and would require €27 billion in financing in the event of a systemic crisis in public equity markets.
Nevertheless, CRML’s professor of finance Michael Rockinger notes a positive trend in eurozone deleveraging. “In most cases, recent drops in systemic risk can be explained by the de-leveraging of the banks,” he says.
“Mediterranean countries such as Italy, Spain and Portugal are making progress and all of them are de-leveraging and decreasing global exposure. As these countries demonstrate, if a will exists to decrease systemic risk, it can be done.
“France is notable in that it has not shown any recent improvement in risk outlook, according to our index.”
French banks underperformed their European peers in recent months, after the Cyprus restructuring and regulatory uncertainty.
Nevertheless, while Europe’s systemically important domestic and global banks continue to trade at a discount to book value – indicating investors have priced in systemic risks and uncertainty over banks’ business models – sell-side analysts are cautiously optimistic about the prospects for the large universal French banks, citing attractive valuations, diverse revenue streams, cost-cutting and say the systemic risks of banks' derivatives exposures are overstated.
While the relationship between equity losses and the systemic risk of a given financial firm is by no means mechanistic – it depends on the nature of the crisis, policy response, a bank's funding model and the composition of counterparty risks – the index is designed to provide a transparent, early-warning system to gauge the expected loss of systemic financial firms during global crises.
More information on the methodology can be found on CRML's website.
League table of systemically risky financial institutions in Europe for the period from April 12 to May 13, 2013