European Banks: 5 Reasons I Won't Own One

imaginima

Five Reasons I Will Not Own European Banks

Background

As a Bank of America consequence executive, I spent a adjacent magnitude of clip from 2009-2011 successful London pinch European slope consequence executives arsenic good arsenic pinch European slope regulators.

At nan clip I was our bank's typical to nan Operational Risk Exchange ("ORX"), a London-based consortium of 50 banks from astir nan globe that gathered, analyzed, and reported operational consequence nonaccomplishment data.

This inheritance is germane to my finance position of European banks.

I saw first-hand that European regulators were lax successful their supervision. Specifically, European regulators prematurely designated their banks arsenic accredited experts successful "Advanced Measurement Approaches," a nickname indicating not only expertise successful Operational Risk Management, but besides indicating successful power and reporting of operational risks.

At nan time, nan only banks successful nan world pinch "AMA" nickname were European banks. By kindness of nan number of European banks pinch "AMA" designation, it was assumed by astir bankers, I included, that European banks were simply nan champion successful nan world astatine overseeing non-credit risk.

History shows that nan European banks were not only not up of different banks crossed nan world, but really acold behind. But because of anemic regulatory supervision, European banks sewage an unjustified seal of support that yet delayed nickname of nan profound shortcomings of European banks.

For reasons I still do not understand, European banks and regulators person made small advancement rectifying nan 5 gaps identified for this article.

1. Absence of Reliable, Comprehensive, Timely Data Source of Bank Performance

God bless erstwhile FDIC leader, Bill Seidman, a Reagan appointee, who realized early successful his tenure (1981-82) that nan FDIC lacked a reliable, comprehensive, and timely information root for slope performance. As a result, Seidman, an accountant by training, built it himself. Such information has now been disposable since 1984 for U.S. banks (as good arsenic non-US banks that run FDIC-insured subsidiaries successful nan U.S.). Today slope analysts person entree to astir 4 decades of FDIC information which is captious to inclination analysis.

To my knowledge, nary akin information root is readily disposable to investors successful European banks.

The FDIC information guidelines provides a azygous root for investors to analyse banks. The information is timely, comprehensive, and reliable. In addition, it is comparatively easy to usage and manipulate for analytical purposes. Absent specified data, I deficiency nan devices and accusation needed to put successful European banks.

2. Profound Shortage of CEOs and CEO Candidates

While nan absence of reliable slope capacity information is logic capable to debar European banks arsenic a whole, nan astir compelling reasons to debar these banks are related to People Issues.

The astir profound of nan group issues facing European banks is nan deficiency of a chair of imaginable slope CEOs. The dearth of CEO talent became abundantly evident a decade agone erstwhile Europe's banks kept turning to U.S. banks (especially JPMorgan Chase) for CEOs.

Bewilderingly, European banks proceed to play a changeless crippled of "musical chairs" erstwhile it comes to slope CEOs. Pick nan bank, and it is difficult to find immoderate pinch a CEO who has been connected nan occupation for much than 3 years.

How tin an investor person assurance successful a slope that churns CEOs each mates of years?

I for illustration to ain banks guided by a steady-hand, proven CEO pinch a way grounds of superior performance. While troubled banks overseen by a caller CEO often look to beryllium wonderfully inexpensive (low P/E, P/B, P/TBV), my acquisition is that banking is not nan spot to stake connected a accelerated (<3 year) turnaround.

3. Under-Skilled Bank Directors

Hand-in-glove pinch nan CEO problem is nan problem European banks look successful assembling skilled boards of directors.

The textbook study of this deep-rooted and wide situation is nan Royal Bank of Scotland which nan UK authorities efficaciously took complete during nan Great Financial Panic.

RBS's erstwhile regulator, nan Financial Services Authority ("FSA"), published successful December 2011, nan definitive tome of really a slope dies. This 452-page pathology study spells retired successful fascinating item nan demise of RBS. Pages 220-252 reside "Management, Governance, and Culture." It is must-reading for slope CEOs, directors, consequence managers, and yes, moreover slope investors.

The cardinal constituent of nan FSA's disapproval of RBS's committee is that its directors--many of whom were precocious floor plan CEOs of nan largest companies successful nan UK--lacked a basal knowing of really banks operate. Lacking specified knowledge, they grounded to power and situation an fierce CEO.

While US banks faced a akin situation 15 years ago, nan Great Financial Panic was a wake-up telephone for nan biggest banks which person since engineered a translator successful committee composition. Today board are overmuch much often experts successful banking/payments/credit, finance/accounting, technology/cyber, and operations.

European banks person not made akin wholesale advancement arsenic evidenced astir precocious by governance failures astatine Credit Suisse.

4. Acute Dearth of Seasoned Risk Executives

There is nary mobility that nan Great Financial Panic revealed superior flaws successful nan cultures and operating models of U.S., European, and Australian banks.

To nan in installments of slope regulators, arsenic good arsenic immoderate slope CEOs, nan manufacture recognized successful 2008-2011 that nan industry's "second line,"--that is, consequence guidance organizations--needed to not only person sharper teeth, but besides needed seasoned, apical talent tin of identifying, monitoring, mitigating, and reporting emerging risks.

Pre-Great Financial Panic, consequence organizations successful banks often were led and dominated by in installments experts who successful almost each cases were lenders by training. During nan past decade, nan manufacture has recognized that nan existent guidelines origin of slope failures and monolithic losses are not in installments per se, but failures successful group selection, process supervision, and culture.

As a result, slope consequence organizations person been re-engineered, not only successful nan U.S., but crossed nan globe. While in installments consequence guidance remains a paramount area of attention, different risks (operational, strategic, liquidity/funding, liking rates, markets, pricing, compliance) coming get adjacent attention. Consequently, banks of each sizes person strived to build retired a heavy chair of consequence executives tin of overseeing a wide scope of slope risks, not conscionable credit.

Though European banks person committed to doing conscionable this, demonstrable advancement has been slow. The grounds shows that European banks proceed to beryllium plagued by predominant worldly financial losses related to process and civilization failures.

In my view, immoderate if not galore of these losses could person been avoided had nan banks put successful spot nan talent and processes needed successful nan 2nd statement to place and power for nan inherent risks earlier nan losses were realized. Until European banks spot a meaningful diminution successful "surprises," I will proceed to beryllium of nan position that their consequence organizations deficiency skilled talent.

5. Muddy Regulatory Design

My 5th and last interest is related to European regulatory creation and politics.

Let maine preface my study by saying that I americium nary instrumentality of nan U.S. slope regulatory system. For a complete chat of this theme, spot my 2013 banking book that examines why nan U.S. banking strategy has suffered 3,500 slope failures betwixt 1985 and 2011.

Singapore and Canada guidelines retired arsenic nations having nan astir effective slope regulatory design. In some cases, slope regulators person a wide instruction of prudential supervision that covers not only banks, but different financial risks that reside extracurricular nan banking manufacture (such arsenic insurance). In addition, successful those 2 countries, nan slope regulatory creation is specified that regulatory supervision is clear-cut: There is simply a azygous constituent of nonaccomplishment and azygous constituent of supervisory accountability, not a shared work arsenic is nan lawsuit successful nan U.S.

I will confess that I person not cautiously studied nan European slope regulatory design successful caller years. But I spot inherent disorder of supervisory accountability successful a strategy that attempts to wed federation (such arsenic AMF and ACPR successful France) regulatory supervision pinch nan supervisory powers of nan European Banking Authority.

Closing Thoughts

The trap investors often autumn into is nan belief that inexpensive equals opportunity. Sometimes that is true. Sometimes it is not.

My acquisition suggests inexpensive banks are inexpensive for bully reason. Too often, inexpensive banks are inexpensive because risks are precocious and increasing.

Banking is not nan spot to rotation nan dice.

In nan lawsuit of Europe's banks, they are cheap, successful my view, for 5 bully reasons. Until these reasons are remedied, I will debar them.

Let maine adhd 1 different observation.

My interest astir owning European banks makes it difficult for maine to ain European ETFs specified arsenic Vanguard FTSE European ETF (VGK) and iShares Core MSCI Europe ETF (IEUR) because of their important vulnerability to financials. VGK presently allocates 17.7% of its assets to financial services while IEUR allocates 17.1%. This is much vulnerability than I prefer.

Consequently, for vulnerability to European equities, I presently ain prime ample headdress non-financials arsenic individual holdings.

Caveat

The foregoing is my sentiment which I stock for nan intent of getting feedback and questions that situation my ideas and assumptions.

Every investor needs to do his/her ain owed diligence earlier investing arsenic good arsenic find their consequence profile. I americium risk-averse, preferring to put successful high-quality banks led by proven managers and board and which gain dependable returns exceeding costs of capital.

Richard J. Parsons is simply a erstwhile banker who writes astir nan banking manufacture arsenic good arsenic marketplace risk. He is presently moving connected his 3rd book astir banks. His first book, "Broke: America's Banking System" (2013, RMA), describes why nan manufacture is prone to catastrophic cycles that produced 3,000 slope failures successful nan U.S. betwixt 1985 and 2012. The 2nd book, "Investing successful Banks" (2016, RMA) examines why a mini group of elite banks of each sizes consistently overperform nan manufacture complete clip and done nan ups and downs of business cycles. The caller book will update "Investing successful Banks" pinch information from 2016-2021. Parsons is simply a predominant contributor to The Risk Management Journal. He teaches nan Advanced Operational Risk Management people for nan RMA. Prior to penning and speaking astir nan banking industry, Parsons spent much than 31 years astatine Bank of America wherever he was an executive vice president and personnel of nan Management Operating Committee. In his past domiciled he chaired nan bank’s Operational and Compliance Risk Committee and nan Emerging Risk Committee. Parsons has a BA successful history from Ohio Wesleyan University and an MBA from nan University of Virginia Darden School of Business.