Analysis: Eurozone bank doubts worse for lack of deposits

By David Henry

NEW YORK (Reuters) - European banks like Societe Generale <SOGN.PA> and Dexia SA <DEXI.BR> are reeling from bad loans, but they are also suffering from a less obvious problem: their reliance on bond markets to fund operations.

Unlike U.S. banks such as JPMorgan Chase & Co <JPM.N> and Wells Fargo & Co <WFC.N>, which fund a greater percentage of their loans using deposits, investor-owned banks in Europe generally depend more on borrowing in the short-term capital markets.

That leaves the European banks exposed to the vagaries of bond investors, who might suddenly demand much higher rates for their money or take it all back and put a bank at the mercy of a government for a bailout

Spikes in short-term rates for some European banks in recent weeks have raised fears of just that kind of meltdown.

European bank shares tumbled as scared stock investors remembered 2008 when Bear Stearns and Lehman Brothers fell because of lack of ready funds to meet their obligations.

The turmoil points to the need for vulnerable European banks to shrink their loan books to sizes more in line with what their deposits can support, or increase their deposit base. Analysts are also calling for more disclosure from the banks around their funding profiles.

"European banking has to be rethought and recapitalized," said one New York-based institutional investor in the money markets who declined to be named because of the risk of alienating clients.

These banks find themselves in a corner. Since the 2008 financial crisis, many have been trying hard to raise more deposits, but it is proving to be tough.

Deposits for investor-owned banks are more difficult to collect in Europe, where banks owned by local governments or by depositors have tax and cost advantages and a stranglehold on the market, said Michigan State University professor Rocco Huang.

Competition for deposits has driven up costs, especially in Spain.

Some banks are looking abroad. Dexia has branched into Turkey to get deposits, but one analyst said that might not be sustainable.

The history of booming countries shows that such new money is unlikely to be as dependable as deposits in long-established accounts, said Morningstar bank analyst Erin Davis.

Dexia declined to comment.


At New York-based JPMorgan in comparison, loans use only two-thirds of the money the bank holds in customer deposits.

To make up the shortfalls, European banks rely on capital markets, including short-term money markets, which can be risky at times of uncertainty like now. (For graphic, please click on )

"In the funding markets, people tend to shoot first and ask questions later," said Mark Pawlak, a strategist and senior vice president at Keefe, Bruyette & Woods in New York. "There's a certain amount of that going on now."

Credit default swaps, a kind of insurance against default, on Societe General more than doubled to 303 basis points on August 19 from the 138 points on May 31, according to Markit.

The bank's stock lost 49 percent of its value in the same time. Meanwhile, JPMorgan credit default swaps rose to just 125 basis points from 75 and its stock fell 21 percent.

The downdrafts came as big U.S.-based money market funds quit rolling over billions of dollars of short-term loans to European banks.

In June and July, the 10 biggest funds took back 18.4 percent, or $70 billion, of the money they had lent to European banks, according to Fitch Ratings.

In a sign of how connected global finance is now, many of the funds said they backed out because they needed money in case investors wanted to cash out in the face of a U.S. government default rather than over worries about European banks. The U.S. funds still had 47 percent of their holdings in European bank instruments at the end of July.

Still, the retreat of the money market funds forced the banks to replace their dollars, which stressed prices in the dollar-funding markets in a way that suggested that some institutions have had trouble getting funds, said Pawlak.

The problem is exacerbated because these banks do not clearly and consistently disclose their liquidity positions, leaving investors to use inadequate proxies such as ratios of loans to deposits and adding to the uncertainty about their health, analysts said.

Societe Generale tried to quell fears by giving more details from its balance sheet in an investor presentation on August 3.

This past weekend, Chief Executive Frederic Oudea said in an interview in the newspaper Le Journal du Dimanche: "The bank does not have any liquidity problems. Its operations are healthy and its investment resources are intact."

A Societe Generale spokesman declined to comment further for this story.

(Reporting by David Henry in New York and Steve Slater in London. Additional reporting by Ross Kerber in Boston, Lionel Laurent in Paris, and Philip Blenkinsop in Brussels; Editing by Paritosh Bansal)