Why there could be more European banking quakes to come

Portugal has had to rescue the venerable Banco Espirito Santo. But there could be more European banking quakes to come

Banco Espirito Santo was very much a family business. The origins of the Portuguese financial group stretch all the way back to Jose Maria Espirito Santo’s “Caza de Cambio”, which opened on a Lisbon backstreet in 1869.

Until last month the group’s bank, whose name means Holy Spirit, was run by Jose’s great-grandson, Ricardo. But what was once a proud family concern is now a ward of the state. The Portuguese central bank announced yesterday that it would be using €4.9bn (£3.9bn) in cash left over from the country’s international bailout fund to split Espirito Santo into a good bank and a bad bank.

The ordinary depositors and senior bondholders of the bank will be protected, but its shareholders and junior creditors will be wiped out in the restructuring.

The financial institution has been laid low by the incompetence of the current generation of the dynasty. It’s a pathetic end to a venerable Portuguese financial empire. And it might be the first in a series of painful reckonings that will hit Europe’s financial sector over the coming months.

The European Central Bank is in the middle of what it calls an “asset quality review” of 124 leading commercial banks across the European Union. Everyone else in the markets refers to it simply as a “stress test”. The results will be unveiled in late October, shortly before the ECB takes over as the eurozone’s official banking regulator on 4 November.

The purpose of the exercise is to restore investor confidence in the continent’s banking sector – confidence that has been sorely lacking ever since the global credit crisis began in 2007.

The Europeans are widely seen by investors as lagging behind the authorities of the United States and Britain in cleaning up their domestic financial systems after the global credit boom and bust of the 2000s.

The sector has a façade of calm thanks to the European Central Bank’s decision to fire-hose commercial banks with liquidity support, and also to the 2012 pledge from the ECB president, Mario Draghi, to do “whatever it takes” to prevent the eurozone breaking apart.

The six-month rate at which European banks lend to each other – known as Euribor – has dipped to just 0.3 per cent for six months. That’s down on the 2 per cent rate seen in 2011 and well below the 5 per cent peak during the global financial crisis in 2008, when mistrust was rampant.

But banks’ share prices are still trading below the nominal value of their assets, suggesting investors fear further write-offs. And with their equity values depressed, the banks themselves are not lending, which partly explains the eurozone’s feeble recovery from its double-dip recession.

Yet a question mark hangs over whether this latest stress test will be effective. This isn’t the first banking stress test that the European authorities have conducted. A similar exercise in 2011 by the European Banking Authority (EBA) quango – including, incidentally, Espirito Santo – failed to quell doubts about the solvency of the sector. Some European banks that were judged to have passed have since fallen into difficulties.

The Franco-Belgian bank Dexia had to be bailed out just three months after being given a clean bill of health by regulators. A damning report last month by the European Court of Auditors found that the EBA had lacked the staff and the powers to conduct an effective stress test.

The former Bank of England governor Lord King warned yesterday that this was likely to be a “last chance” for Europe to clean up its banks and win the trust of investors. Lord King, who was dealing with blowback from the eurozone banking system in 2011 and 2012 when he was in the Threadneedle Street hot seat, issued a warning: “Financial markets will be looking very carefully in the autumn at whether the statements made about the capital positions of different banks are really credible, and a lot hangs on this,” he said.

The president of the European Central Bank, Mario Draghi, has insisted that this time things are different. He has said that some banks will almost certainly fail the stress test and will need to raise more capital. “If they do have to fail, they have to fail. There’s no question about that,” he said last year.

If that is the case then some other institutions are likely to go the way of Portugal’s Espirito Santo. But which? The spotlight is likely to shine on the eurozone periphery. Data from the European Central Bank shows that banks in the crisis-hit states of Italy, Portugal and Spain had the highest non-performing loan ratios in 2012.

That fits with the analysis of the International Monetary Fund, which estimated last year that banks in Spain, Italy and Portugal face about €250bn in potential losses on their loans over the next two years. That equates to about a third of the total capital buffers held by the banks in those three countries. The IMF also cautioned that only the Spanish banking system currently has enough reserves to cover the expected losses.

If this is correct it implies that private investors in banks are soon going to be tapped for more capital. And if this is not forthcoming, national governments will have to step in. If the balance sheet holes are as big as some more bearish analysts fear, that could have tricky financial and political ramifications.

It could even set off a new leg of the eurozone crisis. But that’s assuming, of course, that Europe’s financial regulators do not, once again, decide to give the can of Europe’s hobbled banks one more kick down the road.

PROMOTED VIDEO
News
ebooksNow available in paperback
Sport
Diego Costa, Ross Barkley, Arsene Wenger, Brendan Rodgers, Alan Pardew and Christian Eriksen
footballRodgers is right to be looking over his shoulder, while something must be done about diving
News
i100
Life and Style
gaming
Arts and Entertainment
Carl Barat and Pete Dohrety in an image from the forthcoming Libertines short film
filmsPete Doherty and Carl Barat are busy working on songs for a third album
Arts and Entertainment
films
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Ashdown Group: PR, Marketing & Events Executive - Southwark, London - £35,000

£30000 - £35000 per annum + benefits: Ashdown Group: PR Marketing & Events Exe...

Selby Jennings: C++ Developer – Hedge Fund – New York

$80000 - $110000 per annum, Benefits: Bonus and Employee Investment Scheme: Se...

Selby Jennings: Java Developer Enterprise Specialist –Paris,France

€30000 - €50000 per annum, Benefits: Competitive Bonus: Selby Jennings: Java D...

Selby Jennings: QA Engineer Lead – Hedge Fund – Chicago

$60000 - $90000 per annum, Benefits: Competitive Bonus and Employee Investment ...

Day In a Page

In a world of Saudi bullying, right-wing Israeli ministers and the twilight of Obama, Iran is looking like a possible policeman of the Gulf

Iran is shifting from pariah to possible future policeman of the Gulf

Robert Fisk on our crisis with Iran
The young are the new poor: A third of young people pushed into poverty

The young are the new poor

Sharp increase in the number of under-25s living in poverty
Greens on the march: ‘We could be on the edge of something very big’

Greens on the march

‘We could be on the edge of something very big’
Revealed: the case against Bill Cosby - through the stories of his accusers

Revealed: the case against Bill Cosby

Through the stories of his accusers
Why are words like 'mongol' and 'mongoloid' still bandied about as insults?

The Meaning of Mongol

Why are the words 'mongol' and 'mongoloid' still bandied about as insults?
Mau Mau uprising: Kenyans still waiting for justice join class action over Britain's role in the emergency

Kenyans still waiting for justice over Mau Mau uprising

Thousands join class action over Britain's role in the emergency
Isis in Iraq: The trauma of the last six months has overwhelmed the remaining Christians in the country

The last Christians in Iraq

After 2,000 years, a community will try anything – including pretending to convert to Islam – to avoid losing everything, says Patrick Cockburn
Black Friday: Helpful discounts for Christmas shoppers, or cynical marketing by desperate retailers?

Helpful discounts for Christmas shoppers, or cynical marketing by desperate retailers?

Britain braced for Black Friday
Bill Cosby's persona goes from America's dad to date-rape drugs

From America's dad to date-rape drugs

Stories of Bill Cosby's alleged sexual assaults may have circulated widely in Hollywood, but they came as a shock to fans, says Rupert Cornwell
Clare Balding: 'Women's sport is kicking off at last'

Clare Balding: 'Women's sport is kicking off at last'

As fans flock to see England women's Wembley debut against Germany, the TV presenter on an exciting 'sea change'
Oh come, all ye multi-faithful: The Christmas jumper is in fashion, but should you wear your religion on your sleeve?

Oh come, all ye multi-faithful

The Christmas jumper is in fashion, but should you wear your religion on your sleeve?
Dr Charles Heatley: The GP off to do battle in the war against Ebola

The GP off to do battle in the war against Ebola

Dr Charles Heatley on joining the NHS volunteers' team bound for Sierra Leone
Flogging vlogging: First video bloggers conquered YouTube. Now they want us to buy their books

Flogging vlogging

First video bloggers conquered YouTube. Now they want us to buy their books
Saturday Night Live vs The Daily Show: US channels wage comedy star wars

Saturday Night Live vs The Daily Show

US channels wage comedy star wars
When is a wine made in Piedmont not a Piemonte wine? When EU rules make Italian vineyards invisible

When is a wine made in Piedmont not a Piemonte wine?

When EU rules make Italian vineyards invisible