European investment banks have been struggling due to their gearing into the continued slump in equi...
European investment banks have been struggling due to their gearing into the continued slump in equity markets and a rumour mill which is making investors jittery.
Commerzbank and Credit Suisse are two of the organisations over which speculation is rife contributing a contagion effect impacting the rest of the sector. Talk of insolvency is rife, according to Raj Shant, head of European equities at Newton.
That can be seen in the performance of the Dow Jones European Stoxx Financial Services Index which has lost 20% in euro terms from the 1 September 2002.
Shant says: 'There have been ongoing concerns that a number of German and Swiss banks are facing hardships and potential insolvency. The banking sector has high systemic risks, hence if one of the banks encounters difficulties, it typically has a knock-on effect across the whole sector.
'Consequently, many investors are avoiding the sector, seeking safer assets in which to park their cash.'
Commerzbank is laden with debt and, as a result, the present market conditions are proving very difficult for the bank.
Shant says if European banks do get into serious difficulties then the European Central Bank is almost certain to cut rates to ensure more liquidity in the market.
Nevertheless the concerns Shant alludes to have already dealt a blow to German banks. The Dax Banks and Financial Services Index has fallen 41% from 1 September to 9 October in euro terms.
Hugh Hendry, European equity fund manager at Odey Asset Management, says in difficult market conditions, investment in European banks should be avoided because of their rigid cost structures, which make it hard for them to restructure their business rapidly.
'In Europe there are difficulties in cutting back on staff due to strict EU regulations and union pressure,' he says.
'Therefore banks cannot cut costs by laying off staff. As a result they tend to deal with bad times by over lending to compensate for their high cost structure.'
Another bank that has been punished by the market is Credit Suisse.
Hendry says recently Credit Suisse is among the investment banks worrying the market partly due to some bad acquisitions.
The company's UK life insurance arm, Winterthur Insurance, is having liquidity problems, he says, in some ways recalling AMP's recent problems with Pearl.
'Across the spectrum, I am worried about the Belgium stock, Dexia Bank. The bank used to lend money to local authorities and the government but has expanded into the US insurance market and is now exposed to higher risk.'
Overall European banks have been affected by the rise in credit risk. However, Shant says that in the current bear market bad debts have not risen by much because most companies that have defaulted so far have been high risk companies, which were expected to default. These included telecoms and technology companies.
He adds: 'General corporates have held up so far but over the recent months, corporate default rates have begun to increase.'
In the region, commercial banks and investment banks were the worse hit. Shant says commercial banks have suffered from a fall in the number of mergers and acquisitions and a high cost base are adversely affecting investment banks.
He adds: 'Investment banks have only cut down on 10% of last year's cost base, this is deemed as still being too high.
'Domestic banks have been the best performers because they provide lending against a security, mostly property and have done well because household income in Europe has not been under much pressure.'
Bad debts not as bad as previous bear cycles
Insolvency rumours not likely to be true.
Domestic banks performing well.
High systemic risk of the sector
Corporate defaults on the increase.
Investment banks negatively affected.
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