Winston Churchill once quipped that ‘Democracy is the worst form of government except for all those other forms that have been tried.’ We are reminded of this wisdom when attempting to ascertain the potential for asset quality deterioration and the costs of provisioning that lie ahead as a result of the COVID-19 crisis. While using the last crisis as an indication of how bad things can get is an inherently flawed process, it is, alas, the best we have. On the one hand, there are reasons to believe that proactive government policies, such as loan guarantees and regulatory forbearance, may soften the blow. But on the other hand, the COVID-19 crisis is fiendishly difficult to quantify precisely because of its global and ubiquitous impact. In the words of Niels Bohr, ‘Predictions are difficult especially about the future.’
Europe is not a country…Each of Europe’s banking systems is driven by its own set of drivers, which is why we will examine the most recent crises in the context of each major European country / region. For example, Spanish banks have reported elevated provisions for several years after the burst of the real estate bubble following the global financial crisis of 2008 (GFC), but this phenomenon was specific to Spanish market. On a similar note, Italian bank’s provisions peaked much later in the decade in 2013 and 2016 as the clean-up process accelerated. We therefore look at the 12-year period from 2008-2019 and set the two years with the highest provisioning charges as an analytical ceiling benchmark, focusing on six of Europe’s largest banking markets – France, Germany, Italy, Spain, Switzerland and the United Kingdom.
FranceFor France, we look at a sample of four banks – BNP Paribas, Credit Agricole, Natixis and Société Générale – which together comprise the majority of the French banking system. In the period from 2008-2019, the highest total provisions for these four banks were €21.3bn and €17.1bn, in 2009 and 2011, respectively. The total provisions for these four banks reached €3bn in the Q1 of 2020 implying an annual run rate of €12bn assuming similar level of quarterly provisions during the rest of the year, which would be considerably below the highs reported in the 12 year period. The provisions would have to rise by another 75% to reach the run rate of those in 2009.
Germany & SwitzerlandFor Germany and Switzerland, we look at a sample of four banks – Deutsche Bank, Commerzbank, Credit Suisse and UBS. With two thirds of German banking assets held by cooperatives and savings banks, Deutsche and Commerz are far from comprising the majority of the domestic market, but nonetheless give a representative sample. In comparison, UBS and Credit Suisse comprise a larger portion of Swiss domestic banking assets, but Switzerland also has a healthy system of cooperative and cantonal banks. In the period from 2008-2019, German banks in the sample reported their highest provisions in 2009 (€6.8bn, of which Commerz accounted for €4.2bn) and in 2013 (€3.8bn). Total provisions for German banks in the sample in Q1 2020 reached €1bn , implying an annual run rate of €4bn, similar to that of 2013.
As for the Swiss, 2008 and 2009 had the highest provisioning charges over the last 12 years, of €2.4bn and €1.5bn, respectively. Total provisions for Swiss banks in the sample in Q1 2020 reached €775mn, implying an annual run rate of €3bn, higher in fact that that of 2008.
ItalyFor Italy, we look at a sample of six banks comprising the majority of the Italian banking system – Banco BPM, Intesa Sanpaolo, Mediobanca, Monte dei Paschi, UBI Banca and Unicredit. In the period from 2008-2019, the highest total provisions for these six banks were €26.3bn and €24.3bn, in 2013 and 2016, respectively. The total provisions for these six banks reached €2.5bn in the Q1 of 2020 implying an annual run rate of €10bn assuming similar level of quarterly provisions during the rest of the year. Needless to say, this is a long way off from the highs reached in 2013 and 2016. Admittedly Italian banks just went through a multi-year process of balance sheet cleanup, and therefore the asset quality is in better shape than it has been in a long time. But all that effort is now in question depending on how quickly the economy can restart following the economic shock caused by the COVID-19 crisis.
SpainFor Spain, we look at a sample of six banks – BBVA, Bankia, Bankinter, Caixabank, Sabadell and Santander – which together comprise the majority of Spanish banking assets. In the period from 2008-2019, the highest total provisions for these six banks were €50.1bn and €23.1bn, in 2012 and 2013, respectively. The €50.1bn figure includes a €18bn provisioning charge taken by Bankia, following the merger of seven savings banks (Cajas) led by Caja Madrid, the creator of the institution. But as Chart 8 shows, 2012 was the year all the institutions in the sample reported their highest provisioning. The total provisions for these six banks reached €7.5bn in the Q1 of 2020 implying an annual run rate of €30bn assuming similar level of quarterly provisions during the rest of the year, which would be a similar level to that reported in 2012 without the one-off restructuring provision of Bankia.
United KingdomFor the United Kingdom, we look at a sample of five banks – Barclays, HSBC, Lloyds, RBS and Standard Chartered. In the period from 2008-2019, the highest total provisions for these five banks comprising the majority of the UK banking system were €44.2bn and €41.3bn, in 2009 and 2010, respectively. The total provisions for these five banks reached €8.7bn in the Q1 of 2020 implying an annual run rate of €35bn assuming similar level of quarterly provisions during the rest of the year, which is not too far from the elevated provisioning levels in the years following the GFC.
What next?The Q1 2020 European banks reporting season was perhaps somewhat anti-climactic in that it is simply too early to start ascertaining the cost to the banks’ balance sheet. Q2 will likely see a considerable spike in NPL ratios, which we have not yet seen in Q1. In times of asset quality deterioration it is key to do in-depth asset due diligence to ascertain how bad could things get. Our future reports will also examine the banks’ power to absorb these elevated provisioning costs with earnings.
Head of Research