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European Banking is getting Scary

European Banking is getting Scary

The loss of confidence in the European banking system stemming from the Cypriot crisis will not only weigh on the banks but also but also on the economy of the region.

The European Banking Crisis

The European banking crisis has a dark history, on September 29th 2009, governments of European bigwigs Germany, Iceland to name a few rushed to prop up five ailing financial institutions by infusing cash inflows and nationalizing them, making it one of the darkest days in the history of European finance. The reasons for the  European banking crisis were simple, outsized risks and the failure of European central bank to combat this non compliance. The banks which were hit hard during this period were Fortis, Belgium’s largest bank, British mortgage lender Bradford and Bingley, Germany’s Hypo real estate, which had a balance sheet of over $ 560 million and one of the prominent players in the domestic security market. Once the news of this bailout package was announced in September 2009, financial stocks plunged on the news of the bailout. Shares of Royal bank of Scotland a major financial institution came crashing down. These developments caused a major panic among the public and calming them down is a critical factor during such crisis. Nobody has yet figured how to deal with a fundamental cause of such crisis and the loss of confidence among the European banks over the terms of repayment. The common factor among banks is the “counter party risks” on the possibility of not being repaid. Although, the European central bank, reacted immediately by injecting thousands of dollars to the affected banks, this measure failed to break the vicious circle of interbank lending.

The Cypriot Banking Crisis 2012-13

Cyprus is rich in natural resources, especially natural gas, in the eastern Mediterranean. Similar to other island nations and with its Geo political significance, Cyprus became an offshore financial centre, with nearly 37% of its bank deposits coming from foreign investors. Cyprus banks also became the most preferred investment destination for Russian investors, especially criminals who needed a place to launder their cash. Due to these reasons, the money in Cyprus banks became so huge that its assets being 8 times larger than the national GDP. In order to maximize the returns on the huge money, the bank invested the deposits in Greece. Greece, as we all know is in the news for its role in the euro zone crisis and considered as one of the most risky economy in the world. The Cyprus banks chose to invest the money in Greece due to 2 reasons.

  1. As most of Cyprus is ethnically Greek, the banks figured that they had an advantage of expanding there.
  2. High interest rates on Greek bonds which promised high returns, the Cypriot banks completely forgot that the reason of such high interest rate is because Greek is at the risk of defaulting.

Thereafter, the investments made by the Cypriot banks have failed miserably. The Cypriot banks have lost billions in Greek bonds and would have gone bankrupt if the European central bank refused these banks emergency funding.

According to a Paris based trader “The loss of confidence in the European banking system stemming from the Cypriot crisis will not only weigh on the banks but also but also on the economy of the region. “

Effects of the European banking crisis

Russian investors face the heat

The bailout deal will hit foreign investors badly, especially Russian investors. Russian nationals have an investment in Cypriot bank to the tune of nearly 20 billion Euros of the 68 billion deposited in Cypriot banks. Those with deposits of less than 100,000 euros were spared; however investors having more than 100,000 euros, mainly Russian investors will lose billions of Euros under the terms of the bailout agreement.

Shares come crashing down

Soon after the bailout was declared by European leaders the FTSE was up by only 3 points at 6,396 soon after the bailout package deal and the German DAX was up by only 02 %.

Decline in the profits of European Banks

The European bank crisis has compounded the misery of the European banks by reducing its profitability by 15 billion Euros annually. The most affected one is the Royal Bank of Scotland, which would lose 1.6 billion Euros annually or 22% of pre-tax profits in the year 2013-14.

Restriction on cash withdrawals

Many banks in Cyprus have posed restrictions on cash withdrawals to the extent of 300 euros per day, and when the banks resume their normal operations there would be a limit on the withdrawal limit in the banks. The foreign minister of Cyprus Mr.Ioannis Kasoulides told that this restriction would last atleast till the end of June, and shall be lifted after consultation with the central bank of Cyprus.

The rebuilding process

Europe’s banking industry has been one of the primary causes of the euro zone’s financial crisis. Governments in European countries had to step in to rebuild by injecting cash inflows to aid failing banks. Germany has already taken the initiative by making a proposal to the European commission, the European Union’s executive arm, for the creation of an independent authority to deal with failing banks and stem the crisis.

The Aftermath of Cypriot banking crisis

The Cypriot banking crisis has exposed the regulatory gap between the degree of financial integration manifested in the presence of large cross border banks on one hand and limited regulatory integration exemplified by the country based bank resolution regimes on the other. The crisis would affect the savings of the public and their pension investments. Now the challenge that is ahead for the European leaders are on creating a full fledged banking union to stabilize the financial crisis and turn the tide for the debt crisis. A majority of the 17 countries in the European Union’s want to create a common banking regulator as well as an authority to take action against erring banks. Some of the regulatory measures that the European Union could contemplate are a  legislation to ensure bank failures across the EU are managed in such a way that it will avoid financial instability and has fewer effects on the public savings and investments. Currently there is no EU framework for managing crisis in the banking sector and the lack of regulatory measures hampers the ability of governments to deal with problems in cross border banks. The EU is in the process to prepare a European framework for bank recovery and resolution and is engaging in discussions with key stakeholders on a number of outstanding points. These discussions are being done for the quick implementation of the proposal and revive the European banking from an impending disaster in the future. 

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