The sell-off in shares of large European banking groups does not yet pose a systemic risk to the single currency bloc, the investment house argues.

Big falls in shares of major European banks such as Deutsche Bank and Societe Generale make for stomach-churning reading but the plight of such institutions is not posing a systemic risk to the eurozone, argues Russell Investments, a US firm with $237.3 billion of assets as at the end of 2015. 

Falls in equity markets have started to translate into heavy selling in shares of banking groups, raising questions about their balance sheets and creditworthiness. For example, since the start of 2016 shares in SocGen, which issued Q4 and full-year results yesterday, are down around 28 per cent (as of late afternoon on 11 February). 

“The European financial sector has been selling off very hard this year and there are genuine concerns which underpin the declines. There have been several high profile disappointments this earnings season such as Deutsche Bank, Credit Suisse and Royal Bank of Scotland and there are well-founded worries around future profitability. Most notably, ECB action, rising non-performing loans and emerging market exposure are weighing on the sector,” said Wouter Sturkenboom, senior investment strategist at Russell Investments. 

“The worry regarding ECB action is that a further decline in interest rates will suppress the interest margin of eurozone banks, hurting their profitability. This is indeed likely to happen but the ECB will bear this negative feedback loop into consideration when deciding its policy mix. As a result, the ECB will move gradually and will take mitigating action when necessary. The last thing the ECB wants is a banking crisis,” Sturkenboom said. 

“While the market is rightly concerned about non-performing loans and the eurozone banking system does have fairly chunky exposures to stressed emerging markets, it is at the same time clear that these exposures should be manageable given their size as a percentage of capital. The banking system is well capitalised and well-regulated now that the ECB has taken on its supervisory role,” he continued.

“The problem is that although individually the concerns look both genuine and manageable they become a lot more dangerous from an investor’s point of view when combined with the newly enacted eurozone bail-in regime. The risk of potential losses at an individual bank causing a bank run from either bond holders or deposit holders and thereby creating a vicious cycle across the banking system is real. However, at the same time at the moment there is plenty of scope to deal with individual problem cases without creating a vicious cycle in the system as a whole,” he said. 

“Eurozone banks share of total market cap is now at the same level as in the financial crisis and only slightly above the level reached in the eurozone crisis. Both these previous cases were much more dangerous than the current situation,” he said. “All in all, there is more than a little bit of fear priced in beyond what the concerns call for and the sell-off does look overdone.”