Bank of America published an interesting research report today which argues that European banks have become “too stable” for the good of the European economy.
Over the past couple of years, European banks have had to contend with interest rates that went up 4.5%, a spike in energy costs due to the Ukraine war, and recessionary economic conditions.
Yet loan defaults have hardly spiked, and banks have lost very little money to people not being able to pay back their debts.
Why is this?
Fundamentally it is because following the Global Financial Crisis in 2008-9, European banks became much more cautious. They scaled back their riskier trading businesses and hardly grew their loan books.
An example of the banks’ cautious lending approach is that 25 years ago, UK banks lent out all of their deposits. Today, they lend out only 75% of deposits, keeping the rest in safe securities.
In addition to the banks’ own caution, regulatory reforms have also played a role in limiting losses. Banks hold more capital against bad times and are subject to more stringent behavioural rules than before.
The end result is that banks have become safer than before.
The flip side of this increased regulation and safety is that investors, perhaps irrationally, remain wary of banks. Bank of America in its report argues that relaxing regulations would help bank valuations recover, which would allow them to lend more freely and thus grow the European economy.
Relaxed regulations would be a positive scenario for European banks in the short run, but I am not unhappy about the current strict regulations either. If banks are safe, a larger allocation to them can be made in the portfolio than if they were still as unsafe as before 2008.
European banks pay juicy dividends and buy back their shares at a good pace. They have shown their resilience against adverse conditions over the past couple of years. I am happy to hold them as long as their valuations remain abnormally low.
2024 performance
@triangulacapital +2.7%
$SWDA.L +3.8%
Portfolio changes
Mapfre was sold following poor earnings. It was replaced by Shell.
