Euro Area Banks: An Endangered Species

Abstract

Since the global financial crisis of 2008, there has been a widespread belief that banks have become safer due to new regulatory measures. However, research by Sarin and Summers (2016) finds that markets believe that banks in the U.S. have become riskier since the crisis. In this thesis, I use their methodology to empirically analyze the riskiness of euro area banks in the aftermath of the crisis. Using volatility, beta, credit default spreads, and price-earnings ratios as market risk measures, I find that euro area banks are riskier by every measure compared to US banks. Like recent literature, I also find that the increased riskiness of banks can be attributed to declines in the price-to-book (PTB) ratio since the crisis. While increased regulation and prospects of future regulation are thought to cause this decline in the US and in the euro area, I find that leverage is an additional reason for the fall in PTB ratios in the euro area. The decline in PTB ratios in the euro area is closely related to the decline in euro area banks’ leverage while banks in the U.S. have disengaged from this link. This means that euro area banks rely heavily on increased leverage to generate profits while U.S. banks do not. Because international regulations demand less leverage, euro area banks will not be able to survive and, in this sense, have become an endangered species.