Eurozone - Outlook for financial services
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31 Octombrie 2011 |
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ERNST & YOUNG S.R.L. |
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Executive summary
Banking
• Elevated stress in funding markets remains a key threat to Eurozone banks’ ability to lend. Combined with the need for the financial sector in general to deleverage, there is a growing risk that this could result in a contraction in the supply of credit to businesses and households, not just in the peripheral economies, but also Italy and possibly France.
• At the same time, weaker economic fundamentals are constraining the demand for credit from the private sector. In part, this reflects ongoing pressures to consolidate balance sheets, but a lack of confidence is also causing businesses and households to scale back their spending.
• A strong policy response is needed to demonstrate that Eurozone governments are willing to preserve the monetary union. This could include allowing the Eurozone Financial Stability Facility (EFSF) to guarantee bank debt and moving toward closer fiscal union.
• If governments fail to act, this could result in disorderly defaults by some peripheral governments, leading to a new financial crisis and global economic slump. As reported in Box A in this report, our simulations suggest that Eurozone GDP could fall by up to 2% in 2012 and a further 1% in 2013 in a disorderly default scenario. The resulting strains on banks in the region could reduce lending by more than 6% in 2012 and a further 2% in 2013, with the contraction most evident in the peripheral economies. Credit constraints would add to the pressure on business investment and household spending across the region.
• Moreover, parts of the banking sector would need recapitalizing. Governments in core countries have the financial means to do so, but governments in peripheral countries would need external financial help.
Insurance
• Natural disaster payouts have risen sharply this year, in the aftermath of Japan’s tsunami, New Zealand’s earthquake aftershocks, and hurricanes on the US east coast. This may mean that non-life insurers will need to raise additional capital until the claims flow subsides.
• Industry profitability has not yet recovered in line with premium income, mainly because returns on investment remain below their pre-crisis level. Returns have been hit by stock market declines and low interest rates. For example, our forecasts envisage German bond yields remaining below 4% until mid 2013. With German inflation averaging 1.8% over the next two years, this implies an average annual yield of just 1% in real terms.
• Regulatory reform remains a further source of pressure on profit recovery. The extra scale economies arising from higher capital requirements have already prompted an upturn in merger and acquisition (M&A) activity, especially affecting reinsurance underwriters.
Asset management
• We expect that the recent sharp declines in equity markets will be partially reversed by the end of the year. This should moderate the decline in total assets under management to around -5% compared with a year earlier. Our base case assumes further modest growth in equity markets and a renewed inflow of funds that will support positive growth of 9% in assets under management in 2012. This is reliant on sustainable and timely measures taken to avert sovereign debt and Eurozone crisis.
• A sovereign default would inflict substantial short-term damage on the industry’s performance and reputation, with negative implications for all types of funds. Not only would there be direct losses resulting from write-downs on the value of government bond holdings, but also indirectly as stock markets plunge. It would likely encourage a further defensive movement into commodities, cash and equities in the small number of sectors identified as resistant to recession. However, even sectors that were formerly perceived as resilient are likely to be affected, be it via bank financing constraints or general risk aversion pushing risk premiums and thereby cost of market finance up.
Introduction
Financial markets experienced a renewed bout of turmoil during the summer months, amid concern over the strength of the global economic recovery and a new wave of fears over the Eurozone’s sovereign debt problems. Banks in the region have come under increasing pressure, with disproportionately sharp declines in the value of their shares and market funding becoming increasingly scarce, evoking memories of the 2008 crisis. An important lesson from that episode is that solvency concerns can quickly become self-fulfilling if they result in a withdrawal of liquidity. Once again, the stability of the banking sector is posing a risk to the Eurozone’s economy.
As described in the autumn 2011 edition of the Ernst & Young Eurozone Forecast, the past three months have seen developments that have led us to lower our central forecast for the region’s economy. We now expect GDP growth in the Eurozone to fall to just 1.1% in 2012 from 1.6% in 2011. In addition, risks are even more strongly weighted on the downside, with a probability of 35% that the Eurozone returns to recession. A return to recession would be associated with heightened levels of financial stress or even a full-blown financial crisis if precipitated by disorderly defaults by peripheral governments.
