Post-Brexit Markets

Banks Are Europe’s 'Achilles Heel'

NYSE REUTERSLucas Jackson
Traders at the New York Stock Exchange scramble following the Brexit decision on Friday.
  • Why it matters

    Why it matters

    European banks have had a terrible year so far, and the impact of Brexit is about to make it even worse.

  • Facts

    Facts

    • European bank stocks have fallen heavily in 2016, with many banks down 30 percent.
    • German giant Deutsche Bank is the worst performer in the sector, down 38 percent on the year, and its stock worth less than any time since 1992.
    • Although asset prices took a hit on Friday, market chaos was kept within limits, with observers insisting there would be no re-run of 2008’s financial crisis.
  • Audio

    Audio

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In the London trading room of one global bank, the mood on Friday was almost one of relief, in spite of market upheaval that followed the Brexit bombshell. The system did not collapse. The central banks intervened only verbally.

But relief evaporated when thoughts turned to the future. “Even before this, in the last couple of years, it was hard to get American investors to come to Europe,” warned one trader.

Now, the UK’s decision to leave the European Union threatens to make things much worse. A long slump in the markets or any downturn in the world economy would hit banks hardest. This was why European bank stocks were the big losers on Brexit Friday. The share price of Italian giant Unicredit fell to an all-time low, while Deutsche Bank and Commerzbank lost nearly a fifth of their market capitalization. The index of European bank shares fell by 17.4 percent, the biggest drop in its history.

 

27 p16 Brexit Market Reactions 2-01

 

But Philipp Hildebrand, vice-chairman of Blackrock, the world’s largest investor, does not see a new financial crisis on the horizon.

“On Friday, there were buyers as well as sellers on the market. The banks had plenty of liquidity. There was no sign of a credit freeze. All that was very different from Lehman Brothers in 2008,” he said.

Nevertheless, Mr. Hildebrand, the former head of the Swiss central bank, said the European banks were the “Achilles heel” of the entire system, thanks to their “enormous structural problems.”

Indeed, European financial institutions are caught in a kind of perfect storm. Chronic low interest rates are eating into margins, while tougher regulations are undermining entire business models. Many banks have already had a truly wretched last six months on the market. Losses of 30 percent and more are not uncommon. Now, Brexit is threatening to ruin the second half of the year. And all this comes before even taking the long-term consequences into account.

 

Philipp Hildebrand, vice chairman of Blackrock, the world’s largest investor. Credit: Chris Ratcliffe/Bloomberg via Getty Images

 

Analysts at Independent Research say Deutsche Bank will suffer more than most: it currently generates around 20 percent of its turnover in the UK. In the wake of the Brexit referendum, experts expect the bank to lose almost €250 million in 2016 (around $275 million). Since the beginning of this year, the bank’s stock price has plummeted by 38 percent. On Friday alone, it was down 14 percent. At €13.36, or $14.75, its share price is the lowest it has been since 1992.

“After this dreadful shock, we may see a few short-term upticks in bank share prices, but we are not out of the woods by any means,” said one London trader.

 

27 p16 Brexit Market Reactions 3-01

 

The same could be said for other asset classes having a wretched day on Friday. The pound fell to its lowest level in 30 years. Losses on the London exchange were limited to “only” 3.2 percent, but the German blue-chip DAX index fell 6.8 percent. In the United States, the Dow Jones was down 3.4 percent.

Like many of his colleagues, David Mortlock, head of the London branch of German private bank Berenberg Bank, stayed up all night to gauge the referendum’s impact. After Friday’s panic, he expects a more rational reaction. But this does not necessarily mean the market will change direction.

“Investors will react, volumes will increase,” he said. “Markets are not yet beyond the worst of it, and the next few months will be tough.”

 

27 p16 Brexit Market Reactions 1-01

 

 

Central banks have similar fears. “There will probably be a period of uncertainty and adjustment,” said Jaime Caruana, general director of the Bank for International Settlements, a kind of central bank for central banks. Monetary authorities were ready to intervene if necessary, he added.

But Mr. Hildebrand warned that we must be aware of the limits of what central banks can do.

“Central banks will not solve Europe’s fundamental problems. They can stabilize the system, and they can ensure liquidity in the markets, but it is naive to think that they can create growth,” he said.

 

Michael Maisch is the deputy chief of Handelsblatt’s finance desk in Frankfurt am Main. Kerstin Leitel covers banks and insurance companies. Yasmin Osman is a financial editor with Handelsblatt’s banking team in Frankfurt. To contact the authors: maisch@handelsblatt.com, leitel@handelsblatt.com and osman@handelsblatt.com.

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