European banks are as vulnerable to failing today as they were in the run-up to the 2008 global economic crash and subsequent recession, according to new research.
In the first study to compare sources of systemic risk in European banks, economists found banks in southern countries, including France, Spain and Italy, are highly vulnerable to failure.
Banks in northern countries appear to be more resilient.
Dr Nikos Paltalidis, of the University of Portsmouth Business School, who led the research published in the Journal of Banking and Finance, said: "The European banking system remains highly vulnerable and conducive to financial contagion, which implies that the policies designed to reduce systemic risk are not necessarily doing the job."
“The findings suggest we might need additional policies to better protect the euro zone and increase the resilience of the financial system,” he added.
The researchers modelled a range of inter-connected, dynamic economic shocks on 170 euro zone banks in 16 countries, and the spread of that effect to other countries from 2005-2013.
The researchers used three independent channels of systemic risk - the interbank loan market, the sovereign credit risk market and the asset-backed loan market - to test which banks were resilient and to track how shocks spread between domestic and international banks.
“The results give a vivid picture of financial contagion and the domino effect in the banking sector. The risks are still substantial and a repeat of the last financial crisis is feasible. Our findings indicate that despite all the efforts to improve the resilience of banking, some banks are as vulnerable today as they were before the last banking crisis, they are just as likely to fail,” said Dr Paltalidis.
“In case of a financial or economic shock, we found that banks would experience losses big enough to reduce their capital below the required regulatory minimum, because the quality of equity on the biggest European lenders is not sufficient enough to mitigate systemic crisis,” he added.
Dr Paltalidis said that the models used showed that major banks were at risk despite tighter financial controls.
He explained: “In theory, the new capital rules adopted by ‘systemically important’ banks should be able to endure a 10 per cent fall in the value of their assets before placing panicky calls to the central bank. “
“Also, the euro area banking system seems to be fundamentally solvent, according to several stress tests. However, our study provides ample evidence that this hypothesis does not hold in practice, indicating that similar to the pre-2009 period systemic risk is enormously underestimated once again,” he said.