Fears over a sell-off in the European banking sector have gathered pace after the Stoxx Europe 600 Banks Index, the gauge of the banking sector in Europe, recorded its sixth consecutive weekly decline, the worst streak since 2008.
European banks – which as early as late 2015 were considered to be among one of the safest investments available to investors, due improved economic growth and expectations that inflation would eventually rise from the current lows – are now facing a very delicate scenario as concerns over a global slowdown have increased sharply.
"Europe's banking sector has been seen as a catalyst, with recent worries over bad loans among peripheral banks and, more broadly, a downbeat earning season driving negative sentiment in region," said Neil Mehta, fixed-income analyst at Markit.
A drastic sell-off in oil prices, prompted by Iran's return to the global scene and the ensuing prospect of the ongoing oversupply could worsen as result, has seen crude falling by a quarter since the turn of the year, while jitters over the state of the Chinese economy have not abated, despite Beijing's stimulus measures. Troubles in the European banking sector, however, have been far worse, as the banking index has tumbled by 23% so far in 2016, compared with the 13% drop registered by the Pan European Stoxx 600 Index.
Even considering the challenging macroeconomic conditions, analysts suggested the slump in the sector was unusual, as the European Central Bank has so far continued to adopt a loose fiscal policy, while the European economic posted encouraging signs of growth. However, banks did not seem to be benefiting from the ECB's quantitative-easing programme which, according to Peter Garnry, head of equity strategy at Saxo Bank, was a cause for concern.
"Banks are much more important for the credit mechanism in the economy here in Europe than it is in the US," he said. "There, you have a capital market where it's easier to issue corporate bonds and get funding outside the commercial banking system. We don't have that to the same extent in Europe, and therefore [the current weakness] is a little bit scary."
Accendo Markets' analyst Augustin Eden added European lenders were in fact suffering from the quantitative easing policy implemented by the ECB, indicating the re-emergence of Credit Default Swap (CDS) – a financial contract whereby a buyer of corporate or sovereign debt in the form of bonds attempts to eliminate possible loss arising from default by the issuer of the bonds – spoke volume for the sector's travail.
"Monetary policy that's easy for the consumer has been tough for banks – some might say quite rightly – but what's interesting is that the CDS is once again gracing the newswires. Of course, last time CDS were this prevalent, a few baffled players made their fortunes in the ensuing crash. The downturn being currently experienced by the investment banks was arguably set in play last autumn, so why have their CDS rocketed upwards only now?"
Due to the negative interest rates set by the ECB, lenders have to pay to have cash on their balance sheets and have seen their interest margins shrinking, with loan growth expected to remain subdued due to the high levels of debt in Europe.
Admittedly, however, the abysmal performance of the European banking sector was also down to a series of poor individual displays by the region's banks, which has seen Deutsche Bank lose more than 36% so far this year amid a restructuring plan, while Credit Suisse posted a huge fourth-quarter loss and has fallen by 34% so far in 2016.