Blistering complaints that banks are too big to fail are usually heard from the Occupy Wall Street side of the barricades.
But on Thursday, some bank analysts in the City of London weighed in with their own hard look at the threats posed by Europe’s largest lenders. The analysts, who work at the Royal Bank of Scotland, argue that despite recent efforts to overhaul the financial system, European taxpayers may still have to fork out huge sums to rescue the Continent’s banks in a crisis.
“Europe’s banks are stronger but still too large, and sovereigns remain vulnerable to bank risk,” the analysts wrote in a research note.
The phrase “too big to fail” refers to the belief that some banks are so large that the government would have to bail them out to prevent their collapse from dragging down the wider economy. The authorities of course acted in this way during the 2008 financial crisis. Since then, governments have taken steps that they say will enable them to wind down large banks, and avoid bailing them out, when they get into trouble in the future. But because banks remain so large compared to national economies, skeptics doubt the authorities would actually let them fail in a future meltdown.
The Royal Bank of Scotland analysts have tried to numerically quantify the size of “too big to fail” risk in Europe.
They do that by applying an equation that first estimates bank losses in different crisis situations. The equation then assesses whether the lenders and the region’s deposit insurance funds would have the financial strength to absorb those losses. In most cases, those buffers would be overwhelmed, the analysts say. As a result, they contend that the taxpayers would have to step in to foot the bill. And the burden, according to their work, could amount to many billions of euros.
One way to protect taxpayers would be to press banks to increase their capital — the part of the balance sheet that can cushion a lender against losses.
The Royal Bank of Scotland analysts estimate that European banks would have to raise their capital levels by roughly $660 billion to properly protect taxpayers. Put another way, European banks would need to raise their leverage ratios – which measures capital as a percentage of a bank’s assets – to 5.8 percent. That is nearly double the 3 percent that new international banking regulations require. One or two countries, like Switzerland, may force their big banks to have leverage ratios close to 6 percent. But most European countries aren’t taking a tougher approach.
The analysts may not have been wholly motivated by concern for European taxpayers. The analysts’ job is to provide their investor clients with research on the bonds that banks themselves issue to raise money for their operations. Such bonds are made safer investments when banks hold more capital.
Still, Alberto Gallo, an analyst who helped write the note, thinks the European authorities need to do more to rein in large banks. “Regulators have to level the playing field,” he said. “You can’t always help the big guys.”