Eurozone periphery’s pain to continue as retreat of banks behind national borders exacerbates recession

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  • German, French and Dutch NPLs will have peaked by the end of 2012, but NPLs in the periphery will keep rising
  • Lending in Southern Europe will remain below 2011 levels until after 2016
  • Banks circumvented as bond issuance rises above bank lending
  • Non-life insurers to be hit by lack of consumer spending but life insurers and asset managers to benefit from increase in savings

LONDON, 31 October 2012 – As banks retreat further behind their national borders, bank lending will fall twice as fast as it did following the peak of the global financial crisis according to the EY Eurozone Financial Services Forecast (EEFSF) released today.

There will be a decline of 2% in overall lending this year in the Eurozone. Tight credit conditions will be felt more acutely in the periphery: lending is forecast to decline by 8.8% this year in Spain and by 4.5% in Italy, while in Germany lending will expand by 1.3%. German, French and Dutch Non Performing Loans (NPLs) will have peaked by the end of 2012, but NPLs in the periphery will continue to rise. Bank lending will actually be overtaken by bond issuance for the first time, in a key sign that banks are now being dis-intermediated from the financial system.

Andy Baldwin, Head of Financial Services Europe, Middle East, India and Africa at EY comments: “In response to market conditions and regulation, banks are beginning to retreat behind national borders which is fragmenting the Eurozone financial system. In today’s global economy, capital is ever more mobile and the retrenchment of the banks is resulting in lending constraints that will exacerbate recessions in the peripheral economies. Policy-makers need to be mindful of the rising cost of regulatory compliance and its macro-economic side effects.” Marie Diron, Senior Economic Adviser to EEFSF says: “Only a full banking union with jointly-guaranteed deposit insurance will be sufficient to stem this retreat behind national borders. Given the time needed to develop banking union we see no upswing for lending in the peripheral states in the near future.”

Consumers will bear the brunt as loans to households fall by 6.6% across the Eurozone but the range in impact on individual countries is considerable (-15% in Spain,-7% in the Netherlands, and just -2% in Germany). Corporate loans in the Eurozone will also fall but by a more modest 1.9% (-10% in Spain but +2.5% in Germany) and in the periphery corporate loans won’t recover to 2011 levels until at least 2015 or 2016.

Impact of bank deleveraging will still be felt in 2016
Deleveraging by banks in the Eurozone is still forecast to deepen in the near future. However the forecast for overall decline in assets for 2012 is €290b, significantly less than the €1.6t previously anticipated, reflecting the impact of recent policy moves. As a result the process is now going to be more prolonged with recovery in banking sector assets pushed out to beyond 2016.

Marie says: “The ECB’s action is just a short-term fix for the Eurozone, an aspirin that will numb the pain briefly, but the underlying problems still need to be fixed. Unfortunately there is more pain to come for financial services firms and their dependents while the Eurozone works through its structural problems. Although the process of deleveraging is orderly the impact of deleveraging will still be felt in 2016.”

Banks now being circumvented by those who can access the bond market
In a key sign that the banking system is being dis-intermediated from the financial system, 2012 will be the first year that bond issuance has risen above bank lending. This trend will help larger corporates who have access to the bond markets, but it will not assist their small and medium-sized counterparts. This will also compound the differentiation in prospects for companies in the core and periphery.

Andy says: “It is yet to be seen whether this will be a short-term shift due to current crisis, or whether it becomes more of a long-term trend and the market for investors dealing directly with corporates develops in a similar way to what we have seen in the US. Banks and other lenders need to keep an eye on how this develops.”

Non-life insurers hit by prolonged downturn in consumer spending
The insurance sector across the Eurozone continues to face significant challenges, as interest rates remain at rock-bottom and equities are muted. Meanwhile insurers are being squeezed by payouts for natural disasters and the recession will hold back their ability to pass on the cost through higher premiums. A 5% fall in insurers’ profits is forecast this year, compounding last year's 18% drop.

Consumer spending will be hit by the recession and as business weakens insurers will find it hard to maintain price increases. For example, car registrations in the Eurozone are expected to decline by more than 5% in 2012 and to keep declining in 2013 and as a result motor insurance premiums will fall.

Savings and investments rise but guaranteed product time bomb still ticking
Uncertainty about the economy and the jobs market will drive an increase in precautionary savings and investments products improving the outlook for life insurers and asset managers.

Andy comments: “Operating margins and return on equity have stabilized for life insurers but whereas new business can be adjusted to the low investment return environment, old books of business with interest rate guarantees pose significant risks to profitability. It will be interesting to if the developments around back book consolidation we have seen in some markets is picked up as a broader trend.”

AUM set to end the year 9% up; multi-asset funds to grow by 50% by 2016
As well as the increase in savings, Eurozone asset managers have also benefited from the European Central Bank’s (ECB) bond buying program. The boost to confidence should reverse last year's 6 %fall in assets under management (AUM), with AUM set to end the year up by 9%, driven by growth in the equity markets.

Investors are seeking diversification and while multi-asset funds are currently just a small sector of the market consistently high growth of between 7-9% is forecast between 2012 and 2016. By 2016 these funds will be around 50% bigger than they were in 2011.

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