There is a gigantic hole in the balance sheets of Europe’s banks – from France to Germany, from Spain to Italy. Even the UK, which thought it had put all this behind it with an unprecedented bailout of major banks in 2008, cannot be excluded. The banks desperately need vast amounts of new capital to function properly but discomfited shareholders adamantly refuse to pick up the bill. The only options left to severely-stretched bank management teams – short of issuing new capital to sovereign funds and other foreign investors are taxpayer bailouts and fire sales of valuable, mainly retail assets. European banking really is at a crossroads – the like of which we have not seen in modern times. The sovereign debt crisis is the main cause of this but European banks have made other serious mistakes as well.

The size of the balance sheet hole is conservatively put at €200bn to €300bn at the minimum – but there is vast scope for accounting manipulation in coming up with anyone’s chosen figure. Europe’s politicians are bereft of ideas on what to do. The European Central Bank, having been left relatively isolated for so long has now reached the truly scary point of having to warn that a systemic crisis is imminent.

Nationalisation in the shape of taxpayer-funded bailouts of one form or another is the only option for most big European banks. Disposals of valuable assets – suddenly categorised as “non-core” by desperate management teams – and massive consolidation of domestic banking systems will be the inevitable result. Cross-border mergers on a scale never seen before will follow.

The process has already begun. Société Générale, one of France’s largest universal banks, has just admitted on its website that consumer finance – a major area of foreign investment by SG over recent years is no longer a core business. The next challenge for the Paris-based management team will be to find a buyer willing to pay a good price for a business that (corporate and investment) bankers of the French and Japanese variety tend to sniff at. Private equity players, sovereign wealth funds from Asia and the Middle East and the big Chinese banks must be the most likely buyers. Chances are that the eventual buyer will secure a great bargain.

Few European bankers would argue with the assertion that conditions are now as bad if not worse than they were in 2008, with the qualification that liquidity across Europe’s banking system is said to be somewhat better today.

For now, Europe has too many banks – and too little capital to run them viably. Not everything is as one might expect: “Right now we have sick economies in Italy and Spain – and sick banks in France and Germany”, quipped one of the world’s top international banking consultants. Business is booming for his global network of accounting and consulting firms – and he seems to know more about what is going on than most bank regulators. He, after all has a global perspective – while they are mainly concerned with their own countries.


A quick tour around European banking systems reveals a “mixed bag” to say the least:

  • Germany really does have a strange banking system – with a host of state-owned Landesbanks that keep on getting into trouble, an overall set-up dominated by state-owned savings banks and mutual cooperatives that seems designed to keep politicians in jobs and only one credible global player – Deutsche Bank.
  • Italy’s”Rip Van Winkle” banking system, which came back to life only 20 years ago after many decades of undisturbed slumber, sees itself as world-class but is unconvincing in that role.
  • Spain has two giant banks – BBVA and Santander, a world-class mainly retail player – Banco Popular, and a lot of poorly-run savings banks most of which are now being bailed out by the government at great expense to the Spanish taxpayer. Spain used to be revered by central bankers for the pro-cyclical provisioning policies mandated by its central bank for bank financial accounts – a fact that has long puzzled accountants, who regard Spain as one of the lesser- developed accounting countries in Europe if not the world.
  • France, long regarded as having the most-improved banking system in Europe after the damage inflicted by President Mitterrand’s ideology-driven nationalisation policies of the 1980s, is in serious trouble – mainly because it did what the bank regulators of the world called for, and invested in government securities. With vast holdings of much depreciated eurozone bonds, France is seen as the most exposed major country in Europe to the sovereign debt crisis.
  • The UK has long regarded itself as having the best banking system in Europe if not the world, but the current crisis has destroyed that reputation with the effective nationalisation of such giants as RBS and Lloyds. Pessimistic London bank-watchers say both banks may well need further capital injections this year. They also predict the nationalisation of another major British bank before the year is out.
  • Switzerland’s two major banks – UBS and Credit Suisse – both posing as new-style Anglo-Saxon universal banks, have been through terrible times over the past decade. Swiss taxpayers are rightly questioning whether such a small country can take the risk of hosting two of the world’s largest and, some say most reckless investment banks.
  • Central and Eastern European countries like the Czech Republic, Slovakia, Hungary, Poland, among others with banking systems dominated by Western European-owned banks can only wait and hope that everything will come right in the end. They are not even being briefed on what the eurozone countries are planning to get themselves out of the current quagmire.

Whatever the limitations of Europe’s bank regulators and central banks, there can be no doubt that the balance of power has shifted dramatically in European banks – away from bank CEOs and their management teams – and in favour of finance ministries, central banks and other regulators. In Britain, for example, the Treasury is said to distrust and disregard almost everything it hears from Britain’s banks. This is perhaps unsurprising in view of the self-serving lobbying campaign run by the UK banks against the recommendations of the Vickers Commission on the future of banking in Britain. While bank CEOs are better regarded in other European countries, the likelihood must be that many of the current CEOs of big European banks will have departed within a year.

Without doubt, Europe needs a new banking industry – and European leaders would be well-advised to look to the recent report of the UK’s Independent Commission on Banking for guidance on how to plan a better way forward. The so-called Vickers Commission is by now famous for its recommendation, already accepted by the British government, that retail banking should be ring-fenced within a universal banking group – but its unspoken objectives are much more fundamental and include:

  1. De-leveraging and unwinding the financial conglomerates that are currently Britain’s major banks.
  2. Making it impossible ever again in the UK for investment banks to be built on the back of retail banks.
  3. Forcing the investment banking subsidiaries of universal banks to fund themselves independently and without reliance on the retail bank.
  4. The creation of standalone retail-style banks out of today’s universal banks
The world that Vickers wants to create will take more than a decade to emerge but it will happen and may well resemble – at least in part – the banking industry that existed 30 years ago. More and more countries are beginning to think like Vickers – and even the French will join the bandwagon once they experience the fallout of so-called Anglo-Saxon universal banking. Sadly for French taxpayers, they will not have to wait too long.

Michael Lafferty is chairman of Lafferty Group and co-chairman of Official Monetary and Financial Institutions Forum (OMFIF). This commentary originally appeared on Lafferty.