Tony Ward

July 11, 2016

Tony Ward is chief executive of Clayton Euro Risk

There’s nervousness in the markets following the Brexit vote. Yields on 10-year Treasuries fell to their lowest level this week; the pound sunk to  a 31-year low against the dollar on Wednesday and several British commercial-property funds have blocked investors from withdrawing their money. The UK media are awash with scare stories at the moment – all rather predictable with the markets being twitchy and no political leader to reassure anxious investors.

Brexit’s ripples are also causing problems elsewhere further afield. The vote to leave the EU has pulled the rug from under the share prices of some of Europe’s biggest banks. I, for one, have concerns about European banks: many remain under-capitalised and that could be a problem in these unpredictable times. Joseph Dickerson of investment bank Jefferies said: “The risks are likely to be greater for eurozone banks, given the potential domino effects of Brexit in those countries with relatively weaker capitalised and funded banks.”

Standard & Poor’s forecast that the UK’s departure will reduce growth in the currency bloc by 0.8% in 2017 and 2018, leaving struggling banks even more exposed. New rules that came into effect in January prohibiting state support unless creditors have been ‘bailed in’ make it harder for them to raise capital. James Chappell, a banking analyst at Berenberg, said: “European bank shares have fallen 35% since the start of the year, while earnings forecasts have been cut by 30%. All that is happening is that people are becoming more realistic about the environment. Systemic concerns have not yet been priced in.”

The results of European banking stress tests at the end of the month and guidelines from the ECB on how lenders should deal with bad debts could trigger further selling.

Under changes proposed by the Basel Committee, banks will have to increase their capital based on their operational risk and past record, including fines some have had to pay to the US.  This could force lenders to add 30% or more to their capital bases.

One country, however, causes me particular concern: Italy. Italy’s banks are in trouble and I can’t see the situation improving until a degree of confidence is restored. That will not happen without public funds. Just this week, the ECB ordered Italy’s third largest and the world’s oldest bank, Banca Monte dei Paschi di Siena, to slash its bad debts. With €46.9 billion of non-performing loans on its books, the bank is the worst performer among Italian banks, which are cumulatively saddled with a total of €360 billion in bad lending.

This is worrying. While Italy is in talks with the European Commission over a plan to recapitalise its banks with public money, there are huge concerns as to how they can be rescued without breaking the rules.  This weekend, The Times reported that Italy’s prime minister wants to ‘pump in billions of taxpayers’ cash to shore up confidence’. But other leading eurozone member countries have historically opposed state bailouts. Shares in Italy’s biggest banks have fallen by as much as half since April, and this has been intensified by the Brexit vote. There’s certainly a worry that some Italian banks may go bust. And then what? The risk of contagion and fall-out within the EU. As one analyst put it: ’If there is recapitalisation of Italy, Italy leads to Portugal, Portugal to Greece, Greece to Cyprus’. Italy may need help but then where will it stop?

Nervous times, indeed.

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