European bank shares are getting dragged down to levels not seen in decades, with Friday's rebound barely moving the needle. A big part of the reason is fear of the unknown -- specifically, what kind of losses might be coming down the pipe as the cratering of commodity prices ripples through the energy sector.
While lenders have tried to reassure investors with extra disclosure on how their loan books would perform under a scenario of extreme stress, the problem is that investors just aren't convinced. A big reason for this is that the so-called "stress tests" on loans to oil companies and related businesses just don't seem that stressful. If banks are to get ahead of the market malaise, they should run another round of tests at a much lower oil price.
A look at the latest batch of fourth-quarter results suggests banks have a pretty benign view of commodity prices. ING raised the possibility of more losses ahead "if oil prices were to stay at $30 or below and remain there for an extended period of time." France's Societe Generale expected "no significant impact" after a stress test assuming $30 a barrel. Natixis proved to be the strictest, saying it had tested its portfolio at $20 per barrel in 2016, $25 per barrel in 2017 and $30 per barrel in 2018, pointing to "manageable" losses.
The problem is that $30 per barrel is no longer the radical scenario it once was -- Brent crude nearly touched $26 last week. It may even turn out to be optimistic. Goldman Sachs has said the global surplus of oil could drive prices as low as $20 a barrel if production is not cut fast enough. Morgan Stanley has also mooted $20-$25. Some indicators even suggest oil prices may soon be flirting with the teens, according to Gadfly's Liam Denning and Rani Molla.
It's understandable that banks want to toe a fine line between honest disclosure and spooking the market -- nobody wants to be the first to cry "fire" in a crowded theater. But memories are still fresh of their failure to get ahead of investors when estimating losses from loans such as asset-backed securities or Spanish property.
Exposure to oil and gas matters. While for most banks that have disclosed figures the energy industry only represents around 1 to 5 percent of total loans, on an absolute basis that's still tens of billions of dollars. Any unexpected rise in loan losses could put pressure on banks' capital base. Sure, banks can drag their feet on provisions or strike deals with borrowers behind the scenes, but the sheer amount of volatility hitting the oil market -- the CBOE Crude Oil Volatility Index reached a seven-year high on Thursday -- means investors want more clarity and disclosure, not just reassurance.
So in a jumpy market environment, banks have little to lose from coming clean on just how bad things might get for their portfolios in a genuinely stressful scenario. If $20 a barrel is being suggested by credible forecasters, why not test for $12, a figure one hedge-fund manager says would be more than reasonable? It might also help back up banks' claim that their post-crisis balance sheets can withstand whatever is to come.
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