Last week you saw the European Central Bank and European Commission roll out a new set of rules on the way that banks are to handle their bad loans. The positive takeaway is that future non-performing loans will be covered. This will one day make banks in Europe more resistant to financial crises. Unfortunately the ECB and EC sidestepped the critical issue of the enormous book of a trillion dollars in current toxic loans throughout the euro zone.
This means that the banking system in Europe is still poorly positioned to handle another financial and banking crisis. It reminds you of why you need a gold IRA. American and European banks are heavily exposed to one another’s balance sheets through derivatives. Now is the time to protect your retirement portfolio by learning what gold goes in an IRA. You should look into Gold IRA rollover rules and regulations today before the next crisis materializes.
Value of Toxic Loans in European Banks is Staggering
In the wake of the Global Financial Crisis of 2008, European and American banks took different approaches to the dilemma of their bad loans. A great number of the European financial institutions elected to write down their toxic loan books as little as possible. There was a reason for this decision. If they had been honest in their loan write downs, they would have needed to come up with fresh capital in huge amounts.
As a result of this choice, a decade after the financial crisis many of the European banks are still haunted and paralyzed by their toxic loans. The size of this failed loans mountain now stands at $935 billion (approximately 760 billion euros). This is only the bad debt of the important banks in the euro zone. Countries whose banks are in the worst shape include Italy, Greece, Cyprus, and Portugal. Italian banks represent around $250 billion of this staggering near trillion dollar total all by themselves.
This inaction in Europe stands in marked contrast to the way that the American banks approached the problem of non-performing loans. With help from the U.S. government sponsored TARP Troubled Asset Relief Program they addressed the bad loans directly. This did require the U.S. government to invest $400 billion in the stabilization of the country’s banking system.
Danger of These Toxic Loans
It would be easy to shrug off the bad loans as just numbers on a page. The reality is far different. Toxic loans are a drain on not only the banks involved but also the overall economy. Bank capital is tied up in covering the bad loans. The financial institution managers are unable to look for new and profitable business opportunities. Both of these problems lead to a lack of new loans being made to companies and individuals.
The negative impact on the European economy has been real. The Organization for Economic Cooperation and Development has researched the issue. They have determined that the resulting substantial credit misallocation is one of the main reasons for slower productivity and economic growth in such euro zone nations as Italy. Fixing the problem has so far been elusive.
New Banking Rules Will Address New Loan Issues over Eight Years
Last week the ECB did roll out its new guidelines pertaining to toxic loans. It will take effect for loans that become labelled non-performing starting April 1st. Banks will receive a seven year period to secure the value of the loan with covering capital. The weakness in the new guidance is that these are not legally binding rules. It will be up to the ECB to identify troubled bank cases where it enforces such guideline tools.
Eurozone Sidestepped the Currently Troubled Loans
Unfortunately for the banking system, the euro zone passed on the current near trillion dollars worth of toxic loans. Their new rules only apply to bad loans made going forward. You can understand why they failed to act. If they made all of these banks cover their current massive numbers of toxic loans now the repercussions would be immediate and dramatic.
There would be waves of mandatory increases in bank capital. Investors would hesitate to fund that much additional bank equity. The end result would see the worst lenders forced to close down. This chart shows the solvency ratios of major European banks. Ratios over 100 mean their bad loans are greater than their tangible equity:
What the ECB supervisors need to do is enforce truthfulness on loan book values at the financial institutions. Even this would cause the most troubled banks to suffer failure. At least if they were careful regulators could manage such failure according to an orderly process. It would address the problem of Europe’s many zombie banks.
Cost Sharing for Failed European Banks Remains Unfinished
A key protective measure that the Europeans have been unable to address is bank failure cost sharing. This is necessary to protect smaller countries especially. Even Italy could find itself overwhelmed by a number of bank failures though. Such troubled banks could rapidly evolve into an all out sovereign debt crisis otherwise.
The euro zone has attempted to forge its “banking union” to expand a bank’s financial health beyond the country backstopping it. Yet this union is woefully incomplete. What they have in practice is their Single Resolution Fund. This SRF has only 55 billion euros allocated to it. It is for closing down the failing important multinational banks by buying their assets. One or several large bank failures could consume this amount with ease.
The financial authorities could improve it by providing a line of credit to the fund from the European Stability Mechanism. It would offer more firepower in a significant banking and financial crisis. To be effective though, the ESM needs to be permitted easier access to banks in trouble.
The current ESM rules require that national governments make a significant contribution to failing banks. This is unpopular as it increases already high government deficits and raises the specter of lower sovereign debt ratings. Besides this, several countries in the euro zone are opposed to backstopping other countries’ failed bank debts.
Opposition to Joint Guarantee of Deposits Continues
Germany is the most opposed nation to guaranteeing other countries’ banks. This is not only with the ESM. They are strenuously against a joint guarantee of deposits that would instill more confidence in weaker countries’ banks. German authorities rightly fear that their own government and citizens would end up bailing out Spanish and Italian banks for their poor loan underwriting choices.
It ignores the fact that some German banks are also in trouble. Deutsche Bank is their largest financial institution and one that has struggled now since the Global Financial Crisis. Yet the Germans are still against a European backstop of all current accounts to the presently guaranteed 100,000 euros. Until this is done, a banking crisis in one country will remain a national problem. As Italy has shown though, one country’s banking issues can easily dramatically impact the whole euro zone banking system if they are not addressed.
Gold Is Your Best Line of Defense Against the Next Banking Crisis
Another banking crisis is inevitable with so many toxic loans still present on important banks’ balance sheets. You should not simply sit by and wait for this to happen. Gold offers insurance and protection during market turbulence. This is why you should invest in gold in your retirement portfolio. Now all you need is to learn how to invest in gold.