By The Wall Street Journal
It’s been a dreary October for European banking. Deutsche Bank is writing down €5.8 billion ($6.6 billion) on assets in its investment-banking and retail units. Credit Suisse is preparing for another reorganization and a capital call that could amount to eight billion Swiss francs. Standard Chartered will eliminate 1,000 of 4,000 senior-management jobs. Expect more bad news as another earnings season approaches and other banks come clean about losses and strategic shortcomings.
All of these banks have new managements that are cleaning house, often belatedly. But the bigger story is the toxic interaction between ultra-low interest rates meant to boost economic growth in Europe and the stricter banking regulations meant to prevent another financial panic.
More onerous capital requirements and limits on leverage and other trading activity are the proximate cause for most recent restructuring moves at Deutsche Bank and Credit Suisse. Standard Chartered could face a capital shortfall in a stress test due to be released by the Bank of England in December. Higher capital standards are necessary to make banks less vulnerable in a crisis, but getting there is going to hurt earnings for a while.
Another issue is poor profitability as ultra-low rates wreak havoc with bank business models. With traditional ways of earning a living no longer working, banks are under pressure to boost earnings through other lines such as investment banking, although doing so is less profitable thanks to capital rules.
Consider Postbank. That retail business, which Deutsche Bank acquired in 2010 and now hopes to sell, accumulates savings deposits from individuals and lends mainly to small- and medium-size enterprises. The acquisition five years ago was supposed to diversify Deutsche Bank’s earnings. But low interest rates have reduced Postbank’s opportunities for earning a return on the deposits it holds and stricter prudential regulations hamper its ability to write riskier loans to small businesses.
Like Postbank, Germany’s smaller banks expect pretax profits to fall 25% by 2019 if the current low rates persist, according to a recent survey by the Bundesbank and Germany’s banking regulator.
Monetary mayhem also helps explain Standard Chartered’s woes. The bank is particularly exposed to developing economies in Asia and to commodities, both of which experienced a boom as a result of investments fueled by cheap capital from developed economies. As that tide turns, the bank has to prepare to satisfy new capital requirements with its core businesses under strain.
The result is a conflicted European banking system that isn’t much safer than it used to be but is worse at its traditional function of distributing capital from savers to businesses. More traditional, and stable, commercial banking isn’t reliably generating profits. Investment banking might, but it comes with tighter capital rules.
Now some bankers, such as Barclays’s John McFarlane and Société Générale’s Frédéric Oudéa, are arguing that the solution is to create European megabanks to rival America’s large institutions. This would overcome the economic ill effects of low profitability by producing more banks that are too big to fail. Gee, thanks.
Some will hail this squeeze on bank profits as a good thing—the capital rules are supposed to discourage excessive risk-taking, after all. But banks have to make a living somehow. The better pro-growth and pro-stability solution will come when central banks once again price capital normally.