Banking's Reservoir Dogs

European lenders are under-performing the wider market like never before

Some of Europe's bank stocks haven't been this low since Quentin Tarantino was just making his mark with the bloody hit Reservoir Dogs.

Falling Down

Deutsche Bank shares have tumbled amid regulatory squeeze

Source: Bloomberg

Two of the region's lenders are embroiled in their own bloodbath as regulators force them to cut off some of their own limbs: Deutsche Bank's stock is trading at its lowest since 1992 and Credit Suisse is at its lowest since 1991.

That's not a sign the European economy is in a worse state than the great financial crisis: The economy is still growing, even if there are signs of a slowdown. Signs of financial stress aren’t close to the levels they hit before 2008.

Reservoir Dogs

Credit Suisse and Deutsche Bank are at their lowest since the early 1990s

Source: Bloomberg data

But what it does show is the banking industry's business model has been squeezed by regulators and central bankers -- and investors don't see profitability returning soon. Concern about a slowdown in China and losses from commodities lending is only making the industry even less attractive to investors.

Even after years of post-crisis balance-sheet surgery, revenue is still shrinking and regulatory costs are still mounting. Returns on equity haven't exceeded banks' cost of equity since the crisis. Most of the region's lenders trade for less than book value, indicating investors don't believe their balance sheets.

So when Deutsche and Credit Suisse both posted their worst results since 2008 in 2015, it signalled far more than a cyclical downturn -- investors now see this as the death throes of a business model.

Not all bank stocks are being hurt to the same extent: Barclays and France's BNP Paribas are only down to a level last seen in 2013. Both have large consumer-banking units to fall back on.

And elsewhere in the market, things don't look quite as gloomy. Even if early indicators such as freight volumes and truck orders are slowing, economists still estimate the European Union economy will still grow by 1.9 percent in 2016 and 2017.

That's nothing close to the stress we saw in 2008, when credit markets seized up and fears of toxic debt contagion swept through global banking.

The cost of insuring banks' debt against default has risen, in Deutsche Bank's case to the highest since only 2012. Interbank lending rates, measured by three month dollar Libor, have crept up to the highest since 2009. All signs of stress -- but not the biggest financial meltdown in 25 years.

Even so, European banks have disconnected from the broader market to an unprecedented extent.

From the early 2000s, the European banking sector typically outperformed all other industries; in 2008, however, that trend reversed and the divide has only worsened since then. Since January 2008, the total return of the Stoxx Europe 600 index has been 43 percent, while the Stoxx European 600 banks index's has been a negative 43 percent. The spread between the two indexes is near the widest it's ever been, according to Bloomberg data.

Diverging Fortunes

Shares of Europe's banks are trailing other industries

Source: Bloomberg data

The interest-rate environment explains part of what's going on. The world economy can't seem to get out of the rut of rock-bottom -- and in some cases negative -- interest rates. Negative rates and quantitative easing may help the domestic economy by spurring spending but, along with sluggish inflation, they have helped crush banks' net interest margins.

Banks have also disconnected from the wider economy because of a specific structural change. Banking may be a cyclical business at the heart of lending and borrowing, but regulators since the crisis have forced banks to cut their balance sheets, shutter risky leveraged activities and become more like predictable utilities than volatile echo chambers for financial markets.

There are valid concerns about whether Credit Suisse and Deutsche Bank have a long-term business model -- but that's very different from suggesting the region's industry is about to undergo a crisis like 2008.

It's just in the short term, no investor is sure what China's slowdown, the commodities rout and the turmoil in emerging markets means for banks or the wider economy.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Lionel Laurent in London at

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    Edward Evans at

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