European banks growing bigger, sowing seeds for the next crisis

Written by Bloomberg | Updated: Dec 4 2009, 03:19am hrs
Andrew MacAskill & Jon Menon

European banks are emerging from the credit crisis bigger than before, posing more risk to their national economies. BNP Paribas, Barclays and Banco Santander are among at least 353 European lenders that have increased in size since the beginning of 2007. Fifteen European banks now have assets larger than their home economies, compared with 10 lenders three years ago.

While the EU has grabbed headlines for breaking up bailed-out banks, regulators havent reined in firms that shunned state aid and are too big to fail. European bank assets have grown 25% since the start of 2007, compared with a 20% increase at US lenders. Banks expanded their balance sheets during the credit bubble, borrowing cheap money in the wholesale market to fund loans and investments. Royal Bank of Scotland Group assets ballooned 2,914% in the 10 years through 2008 as it made acquisitions, boosted trading and increased lending. Edinburgh-based RBS spent $140 billion on takeovers during the period, culminating in the purchase of ABN Amro Holding NV in 2007 that triggered the worlds biggest bank bailout. Paris-based BNP Paribas, the worlds biggest bank by assets, increased its balance sheet by 59% to $3.5 trillion since the beginning of 2007, an amount equal to 117% of Frances GDP. Assets at London-based Barclays jumped 55% to $2.6 trillion, or 108% of UK GDP. Santanders rose 30% to 1.08 trillion euros, about the size of Spains GDP.

RBS has pledged to reduce its balance sheet by 40% over the next five years, and the European Commission, the executive arm of the EU, has ordered banks to sell assets as a condition of approving state aid. The EU doesnt have authority over banks that werent bailed out, many of which continued to expand as European economies contracted. Thirty-eight of Europes 100 biggest financial institutions have more assets now than they did at the beginning of the year.

Deutsche Bank, Banco Bilbao Vizcaya Argentaria and UniCredit SpA, all of which expanded over the past three years, have below average risk-adjusted capital ratios, a measure of their ability to withstand losses. More weak banks may be exposed as the ECB withdraws cheap loans that propped up the financial industry last year.

The credit crisis shows that large institutions pose too great a risk to their home countries, especially in Europes relatively small economies. Britain, with an economy one-fifth the size of the USs, faces widening budget deficits, rising unemployment and increased taxes after four bank bailouts, including the 45.5 billion-pound rescue of RBS. The damage was even greater in Iceland, which had to seek emergency assistance from the IMF after the countrys banking system collapsed. European governments overall have provided $5.3 trillion of aid to banks in the past two years.

Bailed-out banks are the nine worst performers in the 64-member Bloomberg European Banks Index since Lehman Brothers Holdings filed for bankruptcy on September 15, 2008. The increasing complexity of banks makes it difficult for regulators and governments to monitor risks, even at firms that appear transparent and stable.

Leaders of the G- 20, including France, Germany, Italy and the UK, agreed in September to develop by the end of 2010 rules that will make banks hold more and better-quality capital and discourage the use of leverage.

In addition, regulators and government officials across Europe have proposed solutions, including forcing banks to separate retail operations from riskier investment banking and requiring lenders to write so-called living wills, that would outline how they would be broken up in the event of a collapse.

Banks increased both the size and leverage of their balance sheets to levels that threatened the stability of the system as a whole, Bank of England governor Mervyn King said in an October 20 speech in Edinburgh. If our response to the crisis focuses only on the symptoms, rather than the underlying causes of the crisis, then we shall bequeath to future generations a serious risk of another crisis even worse than the one we have experienced.

In the US Congress, the House Financial Services Committee is considering a measure giving the government authority to break up healthy, well-capitalised firms whose size threatens the economy. The five biggest US lendersBank of America, JPMorgan Chase & Co, Citigroup, Wells Fargo & Co and Goldman Sachs Group held $8.3 trillion in assets as of September 30, an amount equal to about 60% of GDP and more than three times the $2.5 trillion in assets held by the top five financial companies in 1999.

In the UK, the five largest banks HSBC Holdings, Barclays, RBS, Lloyds and Standard Charteredhave 6.1 trillion pounds of assets, or about four times the GDP. A decade ago, the top five banks had 1.2 trillion pounds in assets. Europes bank bosses have gone on the offensive in recent weeks to head off stricter regulation, arguing that the quality of a lenders assets, not the size of its balance sheet, determines the threat to the economy.

Tony Lennon, president of the UKs Broadcasting Entertainment Cinematograph & Theatre Union, is concerned that the drive for new international rules is slipping away as the recession comes to an end. The financial crisis was like a nuclear reactor on the verge of exploding, Lennon said. Now that the danger of Armageddon has passed, banks and regulators are continuing as if nothing happened.