Vol 10 (2013) - Issue 4

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European Banks: Deleveraging and Non-Core Asset Disposal Programmes

Deleveraging has been high on the agenda of most European banks for a number of years, but despite the efforts that have been made, the size of the task remains largely undiminished. Most of the top 50 banks have now established dedicated non-core divisions, but the sheer size of the non-core pool, combined with the moderate pace of deleveraging, means that it could be at least ten years before the de-leveraging process is completed.
In January 2012, we estimated that European banks held EUR 2.5 trillion of non-core loans. When we updated this analysis in January 2013 we found that despite a EUR 600 billion reduction from asset sales and run-off, there had been additional announcements of non-core assets of EUR 500 billion. Thus EUR 2.4 trillion remains designated as non-core which represents about 5% of overall bank assets and is a mixture of non-performing loans (around EUR 1.0 trillion) and performing loans (around EUR 1.4 trillion).
We believe that the non-core pool could increase further still as banks continue to re-assess what is central to their strategy in the emerging economic and regulatory landscape, what we have termed the 'new normal', and become more transparent about their non-core portfolios and de-leveraging efforts.

The new normal
The new normal is our characterisation of a changed economic environment which reflects three fundamental shifts from the world prior to the financial crisis.
The first change, which is having the biggest impact on banks and deleveraging, is in the financial system. From the 1980s until 2007, Western economies enjoyed an era of easy money. The operation of a highly deregulated and liberalised global financial system provided consumers and businesses with relatively easy access to finance and allowed a build-up of debt. Now, banks have become much more cautious and their reluctance to lend is being reinforced by new regulatory requirements.
The second change is affecting the cost of imports. From the mid-1980s – when oil prices fell sharply – until the mid-2000s, Western consumers benefited from an environment of cheap imports from the rest of the world. Energy and other commodity prices remained subdued until the mid-2000s and the expansion of the world economy to include new sources of low-cost production – including China and India – initially pushed down prices of many manufactured products and provided a further boost to Western living standards.
However, as these large emerging market economies have developed and grown, the tables have turned. Strong growth in Asia and elsewhere in the emerging world is now exerting more inflationary pressure across the world economy. The world of cheap imports has been eroded by successive waves of energy and commodity inflation since the mid-2000s. Furthermore, strong growth in China, India and elsewhere is pushing up their labour costs and adding further to import costs for the UK and other Western economies.
A third change since 2007 has been in the ability of governments and central banks to underpin confidence in the private sector. Before the financial crisis, governments and central banks appeared to be able to support growth, contain inflation and maintain orderly financial conditions. This confidence has been severely dented by the experience of the financial crisis and the difficulty we have had steering our way out of a period of economic turbulence. The recent upheaval in Cyprus shows that the Eurozone crisis is far from over.
So three tailwinds – easy money, cheap imports and strong confidence – are no longer available to support growth in Western economies. The UK and other Western economies are going through a prolonged period of structural adjustment to the new normal world of more restricted finance and higher and more volatile energy and commodity prices. And this adjustment is likely to continue through the mid-2010s.