In the spring of 2007, Europe’s banking sector was comfortably (and excitedly) busy with a series of mergers and acquisitions, and several large banks were set on eating each other whole. Italy’s UniCredit paid more than 29 billion dollars in May last year for its smaller rival Capitalia, creating Europe’s second-largest bank after HSBC. A fierce bidding war for Dutch bank ABN Amro also held the continent’s attention, with Barclays pitting itself against a pan-European consortium comprised of the Royal Bank of Scotland, the Benelux’s Fortis and Spanish banking giant Santander.
Yet once the US mortgage market hit the buffers in late spring 2007 and its impact began to spread around the world, lending of all sorts began to dry up, and many of the mighty looked set to fall.
This has caused significant shifts in European banking priorities. Previously in the mature markets of North America and Europe, lending had risen to historic highs, thanks to booming property prices and a general loosening of regulations. Whereas lenders would typically be allowed to borrow perhaps three times their income in a normal market, by 2006 they were borrowing on far higher multiples and at proportions above the value of their properties, with banks presuming that future rises in value would secure these loans.
Known in the US as “Ninja” loans (“No income, no job”), the practice of issuing loans like this had not been seen in Western markets since the late 1980s, just before the last major house price crash. Since late 2007, conditions have worsened across almost all kinds of banking in Europe. The deterioration has taken place in several stages, each accompanied by a dramatic event. Some of the most notable events in this process demonstrate the fragility of customer confidence in retail banking and the dangers of over-borrowing (Northern Rock), the lack of proper oversight (Société Générale) and the dangerous contagion of market rumours (Bear Stearns and HBOS).
On the Northern Rocks
One of the UK’s largest mortgage lenders, Northern Rock’s business model was to lend money to customers that it had borrowed from other financial institutions at a lower interest rate. Once the credit crunch took hold in summer 2007, it could no longer borrow at these advantageous rates and began to run out of money. This news spread across the UK and its many thousands of account holders queued to retrieve their money in case it went bankrupt. Eventually the UK government took the bank over by nationalising it and bringing security to depositors, but leaving the UK taxpayer with a very large potential liability.
The practice of lending to on-lend, as exemplified by Northern Rock, is now under close scrutiny, with other European governments watching developments with interest. If their own major financial institutions were to get into trouble, would they do something similar — especially if the UK appears to have achieved good results? Regardless, the situation has still been an embarrassment for the UK’s financial regulators — who have admitted that they failed to act in time — and for the British government, which had prided itself on solid financial management.
When 31-year-old French trader Jérôme Kerviel was found to have lost Société Générale almost five billion euros, it was reported by the media as the biggest fraud in financial history, wiping out profits from France’s second-largest bank for 2007 and raising fears that the bank would be acquired by a rival sometime in the coming months or years. Some felt that the heavy stock market losses that happened in the same week as the news of the fraud broke were linked to it. Certainly it did nothing to bolster confidence in banks.
The scandal was seized upon by some commentators as evidence that the banking profession had sunk to new lows. “The banking industry used to have a reputation for honesty, trust and prudence,” said Roger Steare, professor of organisational studies at the Cass Business School in London. “This latest scandal, on top of the massive losses in credit markets and the ongoing incidence of mis-selling to retail customers, indicates that there is a systematic deficit in ethical values within the banking industry.”
The Société Générale case, however, was more about complexity and lack of oversight rather than about an ethical gap. Financial products have become so labyrinthine and pass through so many people’s hands that it can be a Herculean task for individual banks to exactly know the state of their liabilities. These gaps in oversight were further evinced when major banks began to go public on writedowns that appeared to have come out of nowhere, even for bank employees who were paid to be in the know. In many cases, these writedowns went up and up in the course of their publication, as closer scrutiny was made of the exact value lost.
Europe is undergoing a period of turbulence, as in the US, where the older generation of banking managers who grew up in a relatively slow-paced environment, with a few, relatively straight-forward products, is giving way to a generation of managers with highly specialised IT skills, dealing with very complex financial instru-ments, with different risk and reward parameters, operating outside the traditional geographical and financial boundaries. Learning how to avoid Jérôme Kerviel-style scenarios will be crucial for the bankers of tomorrow.
No picnic for this Bear
In the first couple of weeks after the subprime situation in the US hit the international headlines, the financial pages were reporting that Bear Stearns bank in the US had been forced to close two of its large mortgage lending operations because of bad debt. It was not alone, but it was taking a bigger and faster hit than many of the other banks.
Around nine months later, the problems had not gone away and Bear Stearns was effectively bankrupt. It was acquired by J.P. Morgan for a fraction of its value just a year earlier, putting the financial community on notice that even the big boys were not immune to disaster.
A couple of weeks later, Halifax Bank of Scotland (HBOS) in the UK found itself at the centre of an unexpected storm when rumours began to circulate that it was in trouble with bad debt and might have to be sold or go out of business. Its share price plunged. HBOS managers and directors kicked up a big fuss about how outrageous it was that unfounded rumours should be flying around. In a few days, the stock market price returned to normal and it emerged that several of the top directors had quickly bought hundreds of thousands of pounds worth of shares, while they were low, “to show support for the bank,” as they put it. How fortunate for them that the share price quickly rose again...
In better times, such unfounded rumours would not have been given any credence. Today, it is only too possible to imagine a large bank crashing, thanks to Northern Rock and Bear Stearns doing the previously unthinkable. The mood of anxiety in the banking profession had turned to desperation by spring 2008, as the scale of losses across the industry, both in money and jobs, became clear. By mid-March, industry experts were warning of 15 percent job losses in US and European investment banking firms. Research agency Experian estimated that as many as 200,000 jobs would disappear across the global financial services sector during 2008, with 65,000 having gone between August 2007 and the beginning of 2008. In total, 12 million people are employed in financial services in the US and Europe.
Restructuring work is writ large among the new opportunities for graduates in European banking. Many companies in various business sectors such as real estate, retail and indeed financial services are well-run and profitable enterprises with solid customer bases. However, they have over-borrowed and are facing cashflow difficulties as interest rates rise and lending becomes tighter. Banks have a major role to play in helping companies turn themselves around and regain stability.
At the same time, opportunities in the emerging markets of China, India, Russia and throughout Central and Eastern Europe, are providing new scope for many European banks. For example, in March 2008 Barclays paid 745 million dollars for Russia’s Expobank, showing its appetite to do business in a country where lending is rising at 45 percent annually. Deutsche Bank formally launched itself in China in January 2008, as many fellow European banks have done in recent years.
Salaries available in the banking sector will still be among the highest in Europe, but the mood of buoyant optimism that has permeated the sector for the past five or more years has certainly diminished.
What many will find themselves doing this year is working to prevent losses and restructure companies. Many banks have been left with bad debt, from unwisely granted mortgages or from businesses that have failed. European banks are now shoring up their defences and trying not to allow more debt to accumulate. Graduates who understand how the banking landscape is changing and show awareness of the new priorities will find there is still a great range of opportunities in the industry.
There has been so much drama in the European banking sector between 2007 and 2008 that it has, at times, made great television. In less than a year the world has seen the spectacular fall of banking giants, queues of angry customers outside a British bank for the first time since the 19th century, a massive rogue trader scandal in France, tens of thousands of job losses and stories of malicious rumours planted to stir trouble at international banks. Oh, and a global subprime crisis.