Europe’s banks have their own problems
Have a question on the financial crisis? Send it in and we’ll get it answered. Beginning today, The Straits Times consults economists and other experts to get answers to questions the man-in-the-street has been asking.
TODAY’S QUESTION
Why are so many European banks in trouble and needing government help when the original source of the problem was the United States?
IT IS true that the source of the major global problems was US banks granting mortgages to vast numbers of US borrowers with almost no chance of paying them back. Wall Street then repackaged these bad loans in the form of complex investment instruments which were then sold all over the world.
But Europe has problems of its own.
Firstly, European banks also lent heavily to home buyers on the back of rising property markets in their home countries. Just as in the US, the housing bubble has burst and house prices are now falling. This erodes the value of mortgage collateral that banks hold on these housing loans and also increases the chance of default on mortgage loans by borrowers.
A recent Citibank report warned that while the US housing slump is in its second year, Europe’s is just beginning.
Second, in an interconnected global financial system, European banks were exposed to US sub-prime mortgages and other risky assets in Eastern Europe. An IMF report says European banks may have had close to three-quarters of the exposure to US sub-prime mortgages as US banks.
Finally, many European banks had become highly leveraged themselves. This means that the amount of debt they hold is much higher than the size of their assets. Some banks are leveraged as much as US investment banks, which have already fallen to a crisis of confidence.
If significant numbers of depositors decide to ask for their money, European banks may not have enough capital to pay. And with the current global credit freeze, they are finding it difficult to borrow from other banks, who are afraid to lend to each other for fear of not getting their money back.
In short, European banks are facing the same problems as the US. In past crises, Europe has always followed the US into recession, with a slight time lag. This time will be no different.
ROBIN CHAN
Source : Straits Times - 10 Oct 2008
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