European banks have plenty of problems. But they’re taking advantage of a brief window to buy back shares, giving a lift to their stock prices.
Swiss banks UBS and Credit Suisse, as well as London-based HSBC and Standard Chartered, are each planning to buy back $1 billion worth of their stock. Italy-based UniCredit, which operates in several European countries, indicated in early November it was ready to buy back shares for the first time in more than a decade.
Many European banks have never fully recovered from the financial crisis. US institutions quickly unloaded their toxic loans from the sub-prime mortgage market and were driven by Federal Reserve regulators to beef up capital, but European banks still have sizeable, albeit shrinking portions of their balance sheets tied up in non-performing loans.
EU banking union block
In a kind of Catch-22, those loans are blocking progress toward completion of the planned European banking union because politicians in Germany and other northern European countries don’t want their taxpayers to be on the hook to bail out troubled banks in Italy, Greece or Cyprus.
But the lack of progress on banking union makes it difficult to conduct cross-border mergers — which ironically would greatly benefit struggling German banks like Deutsche and Commerzbank. So consolidation in the sector has been blocked, trapping institutions in less-than-optimal structures to achieve meaningful profit.
The sluggish growth of European economies has obliged the European Central Bank to lower benchmark interest rates further into negative territory, squeezing profit at commercial banks even as business languishes.
Within several years, European banks are also likely to also face tougher capital requirements set for institutions worldwide by the Basel Committee on Banking Supervision. Its Basel III guidelines must be adopted by each jurisdiction, including the European Union.
Fresh capital requirements
The rules, which will take effect in 2022 and gradually phased in through 2027, will require banks to hold capital according to the risk level of their assets. Lowering risk also means reducing reward and banks will be saddled with less productive capital.
The European Banking Authority (EBA) has estimated that eurozone banksOpens a new window will need to raise €135 billion in fresh capital to meet the Basel III requirements once they’re fully implemented.
All this means European banks may not be a great long-term investment. Their problems are the symptoms and the cause of a retreat. Fintech firms are chipping away at many of the payment and lending functions banks have conducted in their domestic markets, while European institutions have ceded much of the global activity in areas such as investment banking to the healthier and and more agile US banks.
Making hay while the sun shines
In the short term, however, banks may be attractive as they jump on the bandwagon for share buybacks. Extremely low rates for borrowing encourage firms to take on debt and buy back sharesOpens a new window . Buybacks have supported US share prices and are now doing the same for those in Europe. Net equity issuanceOpens a new window is turning negative as companies retire more equity than they sell.
The EBA is backing full implementation of the Basel III rules but the banking industry is lobbying the European Commission, arguing that Europe faces special problems that make the capital requirements too onerous. Valdis Dombrovskis, the commissioner in charge of financial services, says the EU will take account of any disproportionately negative impactOpens a new window from the rules.
In the meantime, banks are performing well after third-quarter earnings beat expectations and buybacks are becoming more popular. The STOXX Europe 600 Banks index rose more than 20% between mid-August and early November, in all likelihood due to the impact of buybacks rather than any fundamental reassessment of the sector’s future prospects.