Are The European Banks Riskier Than American Banks

Published Date: 02 Nov 2017

Introduction...................................................................................................2

Are the European Banks riskier than American Banks? ..............................2

Net Loan/ Total Asset.........................................................................2

Net interest Margin.............................................................................4

Conclusion.....................................................................................................6

References....................................................................................................7

Introduction:

In the year, 2007 & 08, the financial crisis led to global level of meltdown which majorly started from USA but at the same time even European banks recorded the major losses. However, not all banks got influenced by the meltdown. To be precise, large-complex banking groups with a focus on investment banking recorded major losses (ECB, 2010). It was evident that any bank who was dealing in property investment e.g. housing loans from US to Europe got affected. When banks get damaged then other businesses also suffers who need business loans from them. So, one thing led to another created a mess.

Jones & King (1995) examines modus operandi banks can use to employ in regulatory capital arbitrage and provides evidence on the scale of these activities in the USA. Merton (1995) offers an instance in which, as an alternative of a portfolio of mortgages, a bank can hold the fiscal comparable of that portfolio at a risk weight one-eighth as large. In this assignment, we will be focusing on the data provided for analysis which actually is from pre-financial crisis period i.e. 2002-2007. With this exercise one can develop an understanding where banks failed and how they should have dealt with the scenario.

Are the European Banks riskier than American Banks?

Financial accounting is the best way to ascertain whether any industry or company is risky or not. Ratios can give a clear picture about the health of any company. There are many ratios which can help us to identify banks of which geography was riskier but to answer this question we will take only 2 ratios which can cover the maximum riskiness of any business. Net loan/total asset can check the bank’s liquidity to meet the liability whereas net interest margin can cover the income potential of a bank with the risk attached to it.

Net Loan/Total asset: "The loan to assets ratio measures the total loans outstanding as a percentage of total assets. The higher this ratio indicates a bank is loaned up and its liquidity is low. The higher the ratio, the more risky a bank may be to higher defaults."

[Source: http://www.activemedia-guide.com]

Now, if we closely observe the table 1, then we will get to know that Real Estate & Mortgage Bank’s net loans/ total asset rose continuously from the year 2002 to 2007 which raises the concern. As per the above mentioned definition, the higher the ratio, the more risky a bank may be to higher defaults.

Table 1(i)

Index

Year

Country Code

Specialisation

Net Loans / Total Assets (%)

16060

2002

US

Real Estate & Mortgage Bank

51.41

16060

2003

US

Real Estate & Mortgage Bank

54.51

16060

2004

US

Real Estate & Mortgage Bank

52.54

16060

2005

US

Real Estate & Mortgage Bank

59.05

16060

2006

US

Real Estate & Mortgage Bank

61.21

16060

2007

US

Real Estate & Mortgage Bank

71.49

Let’s see how European Banks did during the same period as per this ratio.

Table 1 (ii)

Index

Year

Country Code

Specialisation

Net Loans / Total Assets (%)

24209

2002

GB

Real Estate & Mortgage Bank

74.36

24209

2003

GB

Real Estate & Mortgage Bank

77.41

24209

2004

GB

Real Estate & Mortgage Bank

73.68

24209

2005

GB

Real Estate & Mortgage Bank

72.17

24209

2006

GB

Real Estate & Mortgage Bank

70.95

24209

2007

GB

Real Estate & Mortgage Bank

70.44

During the same period, Real estate & mortgage bank of Great Britain (GB) continuously kept their net loans/ total asset ratio very high. On this ratio, GB banks seems to be risky but most of the other index number real estate banks kept their net loan/ total asset ratio in control.

To draw a better conclusion, let’s take another European country bank:

Table 1 (iii)

Index

Year

Country Code

Specialisation

Net Loans / Total Assets (%)

16240

2002

GR

Commercial Banks

61.15

16240

2003

GR

Commercial Banks

72.62

16240

2004

GR

Commercial Banks

59.53

16240

2005

GR

Commercial Banks

66.42

16240

2006

GR

Commercial Banks

70.55

16240

2007

GR

Commercial Banks

 

At the same time, German banks were also matching their GB counterparts in terms of Net Loan/ Total Asset ratio. The ratio offers a common measure of the financial situation of an organisation, as well as its capability to meet up financial needs for outstanding loans. A year-over-year decline in this metric would recommend the company is gradually becoming less reliant on debt to grow their business.  On the contrary, European banks were growing this ratio and also they were keeping it around the 70% mark in most of the situations. On this ratio, it seems European banks were riskier than American banks but it doesn’t make them any better.

Net Interest Margin:

As the name indicates, net interest margin is a difference between interests earns & interest paid by banks. The main area of business for any bank is to money through interest. When this starts shrinking or hitting negative that means bank is unable to generate money. Even a stagnant ratio is a concern but it is better than falling or negative ratio. Therefore, in calculating the net interest margin financial constancy is a regular apprehension.

[Source: readyratios.com]

To make an assumption on the riskiness lets first evaluate both the categories of banks. In Table 2 (i), American real estate & mortgage bank kept their net interest margin % fluctuating around 2 but if we compare the percentage in 2002 with the percentage in 2007, then we notice a decline. Which means this bank did well in holding the net interest margin also they kept it in positive figures whereas other few banks in USA witnessed a drop in net interest margin %.

Now, let’s examine the performance of other European banks which is covered in Table 2 (ii) & 2 (iii). Most of the European Banks performed consistently well or atleast they tried to keep themselves in positive but the banks in GB and BE on few occasion earned negative ratio. In both the tables, the figures and banks mentioned in red are the negative ratio years.

None of the Real estate & mortgage bank in USA earned a negative net interest margin but the same category banks in GB not only earned a negative net interest margin but also they managed to reach the highest positive figure. This kind of volatile business operation makes them risky because investors would like to see the organisation in pink of continuous health with minor fluctuations.

Index

Year

Country Code

Specialisation

Net Interest Margin %

16060

2002

US

Real Estate & Mortgage Bank

2.96

16060

2003

US

Real Estate & Mortgage Bank

2.88

16060

2004

US

Real Estate & Mortgage Bank

2.81

16060

2005

US

Real Estate & Mortgage Bank

2.6

16060

2006

US

Real Estate & Mortgage Bank

2.21

16060

2007

US

Real Estate & Mortgage Bank

2.13

Table 2 (ii)

Index

Year

Country Code

Specialisation

Net Interest Margin %

16043

2002

GB

Real Estate & Mortgage Bank

2.26

16043

2003

GB

Real Estate & Mortgage Bank

1.17

16043

2004

GB

Real Estate & Mortgage Bank

9.11

16043

2005

GB

Real Estate & Mortgage Bank

10.35

16492

2002

GB

Real Estate & Mortgage Bank

-82.55

Table 2 (iii)

Index

Year

Country Code

Specialisation

Net Interest Margin %

16269

2002

DK

Real Estate & Mortgage Bank

3.06

13015

2002

DE

Real Estate & Mortgage Bank

2.22

10153

2002

BE

Real Estate & Mortgage Bank

-7.41

18844

2002

NL

Real Estate & Mortgage Bank

3.77

10896

2002

FR

Real Estate & Mortgage Bank

1.86

Conclusion:

After examine the data provide for this assignment, one could tell that neither side of Atlantic banks did well during the period of 2002-2007. Moreover, one could not ignore the fact that both the side of the banks suffered the global meltdown. However, USA bounced back after couple of years but Europe is still struggling and facing one after another bankrupt countries. The data also shows that banks took most of the ratios for granted because since 2002 banks started showing the signs of trouble.

US banks certainly initially looked in trouble because they have more investment & real state banks than Europe. GB is the only country in Europe which can come closer to the kind of operations US banks are or were involved. So, to compare the whole Europe cannot be entirely justified but even if we compare we will find US Banks performed better than most of the European Banks which we found out through risk ratios. Hence, it is true that European Banks are riskier than Ameriacan Banks.