The prominent fund manager Jeffrey Gundlach doesn't mince his words when talking about the European financial sector.
"Banks are dying, and European politicians don't know what to do," the U.S. investor told the news agency Reuters. "When shares in Deutsche Bank drop into single-digit territory, panic will break out."
While Mr. Gundlach may hold extreme views, a warning from Lorenzo Bini Smaghi, an Italian economist and chairman of French banking giant Société Générale, highlights the extent of concern about Europe's banks. As a former member of the executive board of the European Central Bank, Mr. Smaghi is not one to raise the alarm prematurely. Yet even he fears that the punishing drops in banks' share prices over the past few days and weeks could rapidly escalate into a real banking crisis unless politicians and regulators take decisive action.
Banks have lost one-third of their value on the Stoxx 600, a stock index of 600 listed companies in 18 E.U. countries, since the beginning of the year. Some €400 billion ($443 billion) has been wiped off the stock market.
Shares in Deutsche Bank, Germany’s largest bank, have plummeted by 28 percent since Britain's vote to leave the European Union, bringing the bank perilously close to Mr. Gundlach's dismal forecast. This week the bank's share price reached a new low of €11.31. German rival Commerzbank has also plunged to a record low. Massive drops have also been seen in banks' share prices right across the continent.
The immediate trigger for the latest stock market crash is the turbulence in the Italian banking sector: its banks are burdened by €360 billion in bad loans.
Europe's banks are caught in a kind of perfect storm. The increasingly stringent guidelines set by regulators are undermining their business models, and this has been compounded by the ultra-lax monetary policy pursued by the ECB, which is eating up margins.
These problems are now being aggravated by the uncertainty caused by the Brexit vote, which could not only lead to a slowdown in the global economy but could also prolong the phase of negative interest rates. This would have associated consequences for banks: according to the ECB's calculations, over half the revenue of the largest banks in the currency union depends on interest income.
Analysts at U.S. financial services corporation Morgan Stanley also see other ways in which the shock triggered by Brexit could weaken banks. The experts fear a strike by investors, which would hit investment banking particularly hard.
Analyst Huw van Steenis also warns of an increase in non-performing loans and a general reassessment of risks, and has cut his profit forecasts for British and E.U. banks by up to 25 percent as a result.
The immediate trigger for the latest stock market crash is the turbulence in the Italian banking sector. Italy's banks are burdened by €360 billion in bad loans, and the government in Rome fears that the trauma of Brexit could tip the sector over into a genuine crisis.
The U.S. investment bank Goldman Sachs estimates that it could take up to €40 billion to stabilize the Italian banking industry. Italy's prime minister Matteo Renzi is currently grappling with the European Commission, the E.U.’s executive arm, over the rescue of ailing bank Monte dei Paschi. The key question is the extent to which the Italian state is allowed to intervene to help the bank, and whether Mr. Renzi must adhere strictly to new E.U. regulations on bank bailouts. These stipulate that a bank's creditors must also be asked to contribute, as well as its owners.
The Italian crisis has already been discussed by the finance committee of the German Bundestag, or parliament. "Italy won't be able to solve its banking problem alone," says Gerhard Schick, the financial policy spokesperson for the Green Party. He believes the situation is serious and that the local problem could soon become a problem for the euro zone.
A study by the consultancy ZEB, made exclusively available to Handelsblatt, shows the problems that Europe's banks are facing. In their report, the consultants describe the profitability of the 50 biggest European banks as, on average, "catastrophic." The return on equity of large banks in the euro zone was actually 4.5 percent in 2015, well below the cost of capital.
Unless banks change their business models, ZEB consultants fear there could be a "dramatic decline" in profits and capital buffers by 2020. The result would be a giant gap in capital. In this scenario, the consultants assume that the phase of low interest rates will continue for another five years and that banking regulations will become increasingly strict during this time. The experts estimate that the shortfall will come to €445 billion in 2020 - three times as much as all capital increases since 2007.
But even if banks react and cut their costs by 30 percent, for example, the ZEB experts do not believe that they will manage to plug the gap in capital unaided. The problem, they say, is that it is "extremely unlikely" that long-suffering investors will be willing to put up fresh funds yet again.
Globally agreed capital regulations for banks, known in technical jargon as Basel III regulations, are currently being tightened. The Federal Association of Public Banks in Germany also believes there is an enormous need for capital. It calculates that the 17 largest German banks that are directly supervised by the ECB need an additional €78 billion in core capital - more than the banks could raise themselves.
Despite these gloomy scenarios, not all experts are as downbeat about the situation of European banks as Mr. Gundlach. "We currently see no signs of a generalized financial crisis," says Jan Alexander Huber, a partner at management consultancy Bain. He believes that banks have learnt their lesson from the last crisis and invested massively in risk management in recent years. Analysts at Morgan Stanley take a similar view, saying that the recent shocks are "seismic but not a threat to the system."
Elisabeth Atzler is the banking correspondent of Handelsblatt since 2012. Frank Drost is a Handelsblatt Editor in Berlin, covering financial supervision and banks. Michael Maisch is the deputy chief of Handelsblatt's finance desk in Frankfurt am Main. To contact the authors: [email protected], [email protected], [email protected]