While European banks are expecting to increase lending, it means more risk-weighted assets balance sheets. The FT's Alan Livsey explains why many banks might struggle to achieve similar leverage ratio to US banks.
Produced by Filip Fortuna. Filmed by Rod Fitzgerald.
Despite the wobble in some Spanish banks this month due to the crisis in Catalonia, European banks have been on a very good run. The MSCI European Banks Index has jumped by over a third in 12 months, its best performance since 2013. The market anticipates a pick-up in lending activity as the long-awaited recovery in euro economies gets going.
More lending, though, means more risk-weighted assets put on to bank's balance sheets and likely more capital needs. Last year, European banks raised capital to cover most, but not all, of their risk-weighted asset increases. As a result, their leverage, essentially their assets divided by shareholders' equity, rose a bit.
If so, that must worry the European Central Bank. Last week the ECB reemphasised their provisioning guidelines from next year for any new non-performing loans. These were not revised rules, but a reiteration of expected standard practise from well-capitalised banks. Indeed, the ECB proposals don't go far enough think analysts at Berenberg.
To achieve an average leverage ratio, risk-weighted assets to tangible equity of around 14 times, which is similar to the US banks, will require $300 billion of added capital. Some, such as Spain's Sabadell, and in France, Natixis and Credit Agricole, may need more capital in the year ahead to reduce their high leverage.
On the other hand, US banks shouldn't need any further capital to achieve the same coverage. Assume only half of this $300 billion was raised as equity. Even that equates to 13% of the market capitalisation of the European bank sector. That is a reasonable amount of potential dilution and could be worse in share terms if any rights issues are done at big discounts.
True, this leverage ratio could be misleading. European banks do lend us safer sovereign borrowers more than their US peers. That hasn't stopped European banks from raising more equity continuously since 2010. Their share accounts have swelled by half since then while those in the US have hardly changed. European banks' tangible book value per share has not budged since 2009. This shareholder value destruction is likely to continue.