THE FINANCIAL HOUSE OF CARDS

The probability of a new banking crisis and the risk of bankruptcy of even the largest market actors are the topics of regular public discussions in Europe. The latest information that was leaked to media concerns the alleged freezing of the assets of bank customers by European authorities in order to prevent the withdrawal of all funds in case of a probable crisis. While this remains a proposal, the experts believe that the situation is indeed alarming. 

Last year, the European Banking Authority (EBA) conducted an EU-wide assessment of the financial situation of 51 large European banks through the so-called stress tests. The results released in July 2016 demonstrated that the condition of the inspected banks was generally "satisfactory". Yet some banks were close to a minimum required standard (4.5%) in terms of capital adequacy.

Soon afterwards, the International Monetary Fund (IMF) published a radically different assessment, which concluded that about a third of European banks would "die" in the coming years, while only a quarter of the American banks were at risk. Given that the European and the U.S. banking systems possess $31 trillion and $16 trillion in assets, respectively, the European Union will lose banks with total assets exceeding $10 trillion, and the US - only $4 trillion in the coming years, according to the IMF estimate. This means that the European banking system is less stable than the American one, and the possible damage to Europe in the event of a banking crisis will be incomparably more severe than for the United States.

In fact, the bankruptcy of the Spanish Banco Popular, which suffered huge losses from the unprofitable sales of real estate, and the shareholders eventually sold it for a symbolic amount of one Euro to Bank Santander, is an alarming bell. Yet another possible candidate for bankruptcy is Italy, or rather, the banking sector of the country, where debts have grown to critical levels. It got to the point when the Italian government decided to allocate €17 billion to save two Venetian banks, Popolare di Vicenza and Veneto Banca.

However, the existing situation is even worse considering the ongoing tension around the largest European bank, Deutsche Bank. More recently, the bank had to pay large amounts of fines that seriously affected its stability and led to speculations about its possible bankruptcy. One year ago, the U.S. Treasury proposed that Deutsche Bank pays $14 billion to settle claims concerning the manipulations with the prices of mortgage securities before the 2008 crisis. As a result, the parties agreed on compensating half of this amount. But before that Deutsche Bank lost half of its market capitalization after losing €6.8 billion in 2015 and about €1.4 billion in 2016, and then refused to pay dividends for the next two years. Currently, Deutsche Bank is one of the banks with the lowest level of capitalization in Europe.

Deutsche Bank continued facing legal claims in 2017 as well. In late May, the U.S. Federal Reserve System ordered the bank to pay $41 million due to an absence of effective anti-money laundering systems. In January 2017, the U.S. fined the bank again for $425 million for a "mirror-trading scheme" with Russian shares. According to the New York Department of Financial Services (DFS), this involved customers who bought shares in Russia, as well as other interested parties, who sold the stocks through Deutsche Bank’s London branch. Part of the operations took place at the bank's branch in New York.

In March, the Connecticut court ruled that the Deutsche Bank Group Service was required to pay a $150 million fine due to manipulation of interest rates. In April, FRS fined the German bank by $156 million. The reason is unsafe operations in foreign exchange markets. Deutsche Bank will pay another $170 million to settle an investor lawsuit alleging it acted with other banks to manipulate the Euro interbank offered rate, or Euribor. At the same time, the British Barclays PLC agreed to a $94 million settlement and HSBC Holdings PLC agreed to a $45 million settlement. It is clear that the financial weakening of one of the most important banking institutions in Europe cannot pass unnoticed for the entire European banking system given a refusal of the German authorities to support Deutsche Bank.

Thus, a desire of the European authorities to take precautionary measures in the event of a new crisis is quite understandable. Even in this case, the freezing of assets will be only temporary. The objective is to contain a panic similar to the one observed in 2008, when the Royal Bank of Scotland was on the verge of bankruptcy and was saved only thanks to the efforts of the state and nationalization. Either way, ten years passed but the situation still leaves much to be desired, which indicates the risks for a number of institutions.

However, Deutsche Bank stands for additional measures to prevent the impending crisis. Thus, its CEO, John Cryan, has recently called on the European Central Bank (ECB) to stop an overly stimulating monetary policy despite the strong Euro. According to him, although "cheap money" helped states and banks emerge from the crisis, it also led to "even more significant shifts." He noted record high prices for real estate in developed countries, as well as the continued rise of the stock market.

“The era of cheap money in Europe should come to an end - despite the strong euro,” Cryan told the bankers. "I welcome the recent announcement by the Federal Reserve and now also from the ECB that they intend to gradually bring their loose monetary policy to an end." He noted, however, that central banks should still try to prevent sharp losses in financial markets.

The experts are concerned about a dangerous impact of the shadow banking on market, which operates through parallel financial networks, relies on offshore banks and evades the regulations of the classical banking system. According to the Bank of France, the volume of operations in this parallel financial sector amounted to $25 trillion in 2002. This amount has increased to $92 trillion in 2015, according to the report of the Financial Stability Board. In addition, the Bank of France notes that almost half of the money circulating in the shadow-banking sector in 2014 had "systemic risks".

Financial and banking crises largely depend on the political will of political leaders. So, the plans of the new American President Donald Trump to change some of the norms approved by his predecessor are aimed at avoiding financial violations. The UK's withdrawal from the European Union further contributes to destabilization. It is difficult to assess the impact of this decision, as well as the measures of the British authorities to contain financiers. But London can weaken the regulation, which can eventually lead to a tough battle between the financial platforms.

Meanwhile, all these pre-crisis conditions in the financial and banking segment of the Old World are dangerous because they are not limited to the borders of the continent. Eighteen Nobel Prize laureates in economics have recently announced a disappointing forecast about a new world crisis, questioning the stability of the financial world. The greatest minds of the economy warn that there are still gaps in control despite the reforms of the past. The reason for the poll of experts was the statement of the Chairwoman of the Federal Reserve Board, Janet Yellen. In a sensational speech made at the end of June, she stated that there would be no more financial crisis in our lifetimes. Economists do not agree with her, to say the least. Despite the good state of affairs on the stock exchange and the stability of the conjuncture, it is a mistake to believe that stability has come. "I wouldn't bet on this statement... Every time we think that there will be no more bankruptcies, the risks increase", said Bengt Holmström, a Nobel laureate in 2016. His colleague, the 2004 Nobel Prize laureate, Edward Prescott, was even more categorical: "With great certainty, we can say that there will be a financial crisis in the near future." Daniel McFadden, Nobel Prize laureate of 2000, is the most adequate in his pessimism: "The financial risks move like electricity through a vast network. And even small problems can easily infect the entire system as in a short-circuit. Unfortunately, the world has not developed the proper mechanisms to survey, regulate, and manage its instabilities. Therefore, a new financial crisis is inevitable," warns McFadden.

In short, the "house of cards" of the global financial system is rather shaky, and the European banks can become the "hand" that pulls out the bottom card.