European banks are losing deposits as savers and money funds spooked by the region’s debt crisis search for havens, a trend that could worsen economic and financial conditions.
Retail and institutional deposits at Greek banks fell 19 per cent in the past year and almost 40 per cent at Irish lenders in 18 months. Meanwhile, European Union (EU) financial firms are lending less to one another and US money market funds have reduced their investments in German, French and Spanish banks.
While the European Central Bank (ECB) has picked up some of the slack, providing about euro500 billion ($685 billion) of temporary financing, banks are cutting lending, which could slow growth in their home countries. They’re also paying more to keep and attract deposits — or, in the case of Italy, selling bonds to retail customers for five times the interest they offer on savings accounts — which will erode profitability.
“All of this is symptomatic of a lot of fear in the European financial sector,” said Kash Mansori, senior economist at Experis Finance in Charlotte, North Carolina, which advises US and European companies. “It shows that even European banks don’t trust each other anymore, so they’re taking their money out of the EU system. It’s similar to the distrust that happened worldwide in 2008.”
DEPOSIT EROSION
Deposits by financial institutions in Greek banks, which make up 21 per cent of the total, have fallen by one-third since the beginning of 2010, while those by non-financial firms and residents dropped nine per cent, according to Bank of Greece data.
In Germany, deposits by financial institutions, which account for one-third the total, declined 12 per cent over the same period and 24 per cent since the September 2008 collapse of Lehman Brothers Holdings Inc., ECB figures show. In France, where the erosion started last year, the same type of deposits, which make up half the total, are down six per cent since June 2010. They have fallen 14 per cent since May 2010 at Spanish banks, where they account for one-fifth of the total.
Deposits include money kept in banks by individuals and companies. Most of the short-term funding supplied by financial institutions and money funds is counted as deposits by the ECB and other central banks in Europe.
While retail deposits at Italian banks have fallen only one per cent in the past year, the outflow of money from financial institutions has exceeded $100 billion, a 13 per cent decline, according to Bank of Italy and ECB data.
MONEY-FUND WITHDRAWAL
Some of the retail deposits have been invested in bank bonds sold directly to retail clients that pay as much as five per cent, compared with an average interest rate on deposits of 0.88 per cent. Retail investors in Italy own about 63 per cent of bank debt, compared with a European average of 48 per cent, data compiled by the Bank of Italy and banking association ABI show.
In Portugal, where banks raised the interest rates they pay savers, non-residents have reduced deposits by 19 per cent since March 2010.
The eight largest US money-market funds halved their lending to German, French and U.K. banks over the past 12 months and stopped financing Italian and Spanish financial firms, according to data compiled by Bloomberg from investment reports.
A survey by Fitch Ratings showed that US money-market funds reduced their lending to European banks by 20 per cent from the end of May through July. The funds cut investments in Spanish and Italian lenders by 97 per cent, to German firms by 42 per cent and to French ones by 18 per cent, Fitch said. The August 22 survey covers almost half the $1.53 trillion assets held by money funds in the US.
RELYING ON ECB
Moody’s Investors Service on Wednesday cut the long-term debt rating one level on Credit Agricole SA and Societe Generale SA, the country’s second- and third-largest lenders by assets, citing the euro region sovereign debt crisis and concerns about “the structural challenges to banks’ funding and liquidity profiles.” BNP Paribas (BNP) SA, France’s biggest lender, was kept on review for a possible cut. BNP fell 2.5 per cent at 10.25 am in Paris trading, while SocGen declined 2.6 per cent. Credit Agricole rose 2.5 per cent.
To make up the deficit, firms are leaning on the ECB for short-term funding. Borrowing by Italian lenders from the central bank more than doubled to euro85 billion between June and August. Greek and Irish banks each took about euro100 billion from the ECB in August. Irish lenders also got euro56 billion from their domestic central bank. Portuguese banks borrowed about euro46 billion from the ECB, while Spanish banks took euro52 billion in July.
‘LEFT WITH GARBAGE’
By accepting those countries’ bonds as collateral in exchange for funds, the ECB is piling up risk, said Desmond Lachman, a fellow at the American Enterprise Institute in Washington. In the event of a default, the ECB’s losses would be borne by the EU’s member states. Lending to the region’s banks by the ECB and other central banks is about seven times the capital of the Eurosystem, the consolidated balance sheet of all euro zone central banks.
“If there are sovereign defaults, the ECB will be left with garbage that has been accepted as collateral,” said Lachman. “It’s putting EU taxpayers’ money at risk in a very non-transparent way. But there’s no alternative. The ECB is the only game in town.”
ECB DEFENDS ACTIONS
William Lelieveldt, a spokesman for the ECB in Frankfurt, declined to comment about the risk to the central bank. ECB President Jean-Claude Trichet has defended his institution’s actions. European banks have more collateral that they can place with the ECB in exchange for additional financing if they need it, he said September 8 in Frankfurt.
“We stand ready to provide liquidity as we have done in the past,” Trichet said.
The outflow of deposits is a measure of eroding trust in the region’s financial system. Banks outside of Greece, Ireland, Portugal and Spain have $1.7 trillion at risk in loans to those countries’ governments and corporations, as well as guarantees and derivatives contracts, according to the Bank for International Settlements.
Concern that those nations will default or leave the EU and devalue their currencies has hastened the flight, according to Dimitris Giannoulis, a Deutsche Bank AG analyst based in Athens.
People “are now afraid of the possibility of returning to the drachma,” said Giannoulis, referring to the Greek currency in circulation before the country adopted the euro in 2001. “Just a headline is enough to spook depositors.”
IRISH BANKS HURT
Irish banks have been the hardest hit. Losses on the collapsing real-estate market and a government guarantee of bank liabilities forced the nation to seek EU assistance in November. The money started flowing out in early 2010 as confidence in the government’s ability to support the banks waned, and it accelerated later that year after Ireland’s rescue by the EU led multinational companies to move deposits out of the country.
Ireland took control of five lenders and is winding down two of them. Even Bank of Ireland, which wasn’t nationalised because its losses weren’t as catastrophic, saw deposits dwindle by euro20 billion euros, or 23 per cent, last year.
At Allied Irish Banks Plc, Ireland’s second-largest lender, deposits declined 37 per cent over the past 18 months. The bank said July 25 that most of the drop occurred at the end of 2010 and in the first quarter of this year as companies pulled money amid sovereign and bank downgrades. Deposits since the end of the first half have been “broadly stable,” said Alan Kelly, the lender’s director of corporate affairs and marketing, who declined further comment.
‘AFRAID OF THEM’
While “the rate of outflow is falling,” Finance Minister Michael Noonan said on September 1 in Dublin, that hasn’t soothed savers such as Phil Carey, an 86-year-old mother of eight from Galway in western Ireland.
“I wouldn’t trust the banks,” said Carey, who keeps her savings at credit unions. “I’d be afraid of them. Look at the money they gave to the builders and the terrible situation we’re in now.”
It isn’t easy for retail depositors such as Carey to move funds abroad. In Ireland, there has been some shift to units of foreign banks operating in the country. RaboDirect, the Irish online-banking unit of Utrecht, Netherlands-based Rabobank Group, saw deposits rise about 40 percent in 18 months, according to General Manager Roel van Veggel.
TAX AVOIDANCE
While the implosion of Irish banks led the government to seek an EU bailout, in Greece the state’s finances collapsed first. Now Greek lenders are feeling the pain because they own about euro40 billion of their government’s sovereign debt. If they have to take losses of 40 per cent or more on those bonds, it would wipe out all the capital held by the country’s banks, the European Commission estimated in July. Greek government bonds are already discounted by 60 per cent in the secondary market, according to data compiled by Bloomberg.
In addition to fearing a drachma conversion, some affluent Greeks are moving money out of the country to avoid having their bank accounts become targets for tax collectors, said Antonio Ramirez, an analyst at KBW Inc in London.
“As the government starts looking for revenue, starts fighting tax evasion, wealthy families move their money out,” said Ramirez, who covers Greek, Irish and Portuguese banks.
That dynamic is also at work in Italy, according to Carlo Alberto Carnevale-Maffe, a professor of business strategy at Milan’s Bocconi University. Deposits at Milan-based Intesa Sanpaolo SpA, Italy’s second-biggest bank by assets, fell 4.4 per cent in the year ended in June.
‘UNDER THE MATTRESS’
“People are moving deposits into safe goods such as gold and safety-deposit boxes,” Carnevale-Maffe said. “They’re simply putting the money under the mattress to avoid taxes.”
Intesa CEO Corrado Passera said on an August 5 call that the decline was the result of a decision to discontinue some institutional funding and the sale of retail bonds.
“In terms of flight to quality, no, I must tell you that we are not experiencing in our country anything like that,” Passera said.
European lenders are also moving money out of the region. The cash that foreign banks keep at the US Federal Reserve has more than doubled to $979 billion at the end of August from $443 billion at the end of February, according to Fed data. The increase in bank deposits at the ECB has been smaller, suggesting that healthy European firms are putting money in the Fed instead of lending to weaker banks, according to economist Mansori, who also writes a blog called “Street Light.”
BANK LENDING
“Do you want to keep your money at the Fed, which you know will pay you back, or at the ECB, which has lots of periphery euro zone country debt?” said Mansori.
The reluctance of European banks to lend to one another has been on display since last month. The spread between Euribor and the overnight indexed swap rate, which reflects the higher risk of lending euros for three months versus overnight, widened to 0.85 percentage point on September 13. The rate compares with 0.36 percentage point at the beginning of August.
Banks can’t continue to rely on the ECB for funding because that’s a sign of being on “life support,” so they’ll have to shrink their balance sheets, said KBW’s Ramirez. That means reduced lending in countries where growth is stagnant.
Lending by banks in Ireland declined nine per cent in the past year, three per cent in Greece and Italy and about one per cent in Portugal and Spain, according to ECB data. Gross domestic product in Italy expanded 0.8 per cent in the second quarter from a year ago and 0.7 per cent in Spain. Greece’s economy shrank 7.3 per cent, while Portugal’s contracted by 0.9 per cent. Irish GDP growth was 0.1 per cent in the first quarter, according to the latest data available.
IRISH CUTBACKS
Ireland said in March that its surviving banks would wind down more than euro70 billion of loans. Most of the reduction will be lending to borrowers outside Ireland, which could hurt growth in other EU countries. Greek banks, unable to sell sovereign bonds they hold, will also have to trim their loan books, according to Ramirez.
“It’ll aggravate the recession,” he said.
While banks say higher capital requirements will curb lending and economic growth, it’s the lack of capital in the European banking system that’s spooking depositors and other creditors, said Lachman of the American Enterprise Institute. That’s why the International Monetary Fund is pushing for recapitalisation of the region’s banks, he said.
Paying more for deposits to prevent them from leaving, as banks in Ireland, Spain and Portugal are doing, will hurt banks’ chances of rebuilding capital through earnings. Offering higher interest rates for retail bonds as Italian lenders have done will cut into interest margins.
‘NOT SUSTAINABLE’
“It’s not sustainable for this type of pricing strategy to continue,” Rabobank’s Van Veggel said about the high rates Irish banks are offering for deposits. “But I don’t think rates will start to come down until nervousness about European, and indeed global, issues calm down.”
German and French banks are losing funds because they hold the most debt linked to troubled euro zone countries, according to Mark Schaltuper, an analyst at Business Monitor International, a London-based consulting group. Investors and creditors worry that German and French lenders will face losses on their holdings in the event of a default, he said.
“European policy makers are kicking the can down the road, waiting for banks to recapitalise slowly so they can take these losses over time,” said Schaltuper, the firm’s chief European analyst. “Until the debt situation in the periphery is sorted out, these funding troubles won’t end.”
