European Zombies Haunting the Economy

The walking dead are gnawing at Europe’s weak economy—zombie banks and zombie companies.

Almost a decade after the financial crisis ravaged the global economy, analysts and top officials are warning that too many banks in Europe are struggling financially, keeping them from lending to companies and fostering growth, AP reported.

Calls to fix the problem have come repeatedly from the International Monetary Fund, US Treasury Secretary Jacob Lew and European Central Bank chief Mario Draghi. They say something has to be done if Europe’s economy is to gain more traction and bring down unemployment.

Here is a look at Europe’s slow-burning banking crisis and how it hurts the economy.

 Bad Loans

Soured loans are one of the biggest problems, especially in Italy.

They create a vicious cycle: The slow economy means businesses can’t repay their loans. That leaves the banks short of cash to finance new business ventures, which holds back the economy even more.

Getting rid of the bad loans is a struggle. Italy’s Monte dei Paschi is trying to offload €27.7 billion ($31 billion) in such loans to investors who would buy them at a deep discount. The bank has to get rid of those problem assets before it can credibly ask investors for more money—up to €5 billion through a share offering.

In Italy, one reason clearing bad loans can be difficult is that the courts are clogged, meaning it can take years to pursue the debtors and recover money. That makes the assets worth even less, and the lower the price, the bigger the financial hole the bank has to fill.

 Zombies

Banks under financial pressure, meanwhile, tend to prop up “zombie” companies by extending loans rather than pressing for repayment.

A group of economists has found that banks under stress tend to maintain credit to companies they already have a relationship with, even if those companies are struggling. Yanking credit to such companies would mean recognizing the bank’s own losses on the loans.

The economy of the 19 eurozone countries grew by a quarterly rate of 0.3% in April-June. That’s not enough to bring down the 10.1% unemployment rate quickly enough.

 Falling Stocks

Weak share prices for banks have compounded the problems, as they make it harder for banks to raise money from investors.

The STOXX Europe 600 Banks index is off 21.9% this year, compared with a milder 7% drop for the broader STOXX Europe 600. Deutsche Bank is off 52% for the year to date, Monte dei Paschi is off 86% and Switzerland’s Credit Suisse 37%.

Deutsche Bank’s shares plunged after it was reportedly facing a US fine of up to $14 billion related to dealings in bonds backed by shaky mortgages before the financial crisis.

 Skimpy Profits, Big Problems

All of this would be less of a problem if banks made enough money to build new capital reserves. But earnings have been sagging, too.

Return on banks’ loans and investments has not recovered to the levels seen before the crisis. Even banks in countries that have had fewer problems—Austria, France and Germany—have seen returns rebound only to around 0.8% from 1.3% before the crisis.

Deutsche Bank made a scant €20 million profit in the second quarter despite €7.4 billion in revenue. That followed a €6.7 billion loss in 2015.

Banks argue that part of the problem is that the ECB has slashed the interest rate benchmark to zero, which squeezes bank’s profit margins.

 Too Many Banks

The ECB and IMF argue that European banks should fix their underlying business models: Their costs are too high, and they have too many branches. The answer may be mergers and job cuts across national boundaries.

 No Bailouts

The banks’ situation is further complicated by new European Union restrictions on government bailouts.

The new rules, which took effect this year, are meant to protect taxpayers from picking up the bill for rescuing banks—as happened during the financial crisis, overwhelming entire states’ finances as in the case of Ireland.

The restrictions raise the possibility that shareholders and junior bondholders—investors who loaned the bank money without getting collateral or a promise of priority repayment—would be required to take losses before government money could be used.