“European banks are at the epicenter of our current concerns and should naturally be the priority for repair,” she said.
Ms Lagarde, who since her start at the fund has focused on banking problems in Europe, left little doubt as to how the issue should be approached.
“Let me be clear,” she said in her speech. “The heart of European banking repair is in Europe. This means more Europe, not less. Less Europe will be bad for the continent and bad for the world. So policymakers in Europe need to take additional steps now to put monetary union on a firmer footing.
At the root of the problem is a simple fact: just like the countries in which they operate, most European banks are highly leveraged entities. They rely heavily on borrowed money to function day-to-day, whether granting loans or paying interest to depositors.
For decades, the loans that European banks have extended to individuals, businesses and their own spendthrift governments have far exceeded the deposits they have been able to collect – the money that is usually the main source of funds available to a bank. To fill this funding gap, which analysts estimate at around 1.3 trillion euros, European banks have borrowed massively from foreign banks and money market funds. This is why European banks have an average loan-to-deposit ratio above 110%, which means that on any given day they owe more money than they have on hand.
In Spain, the problem was even more acute. Bankia, before its bankruptcy, had a loan-to-deposit ratio of 160%, one of the highest in Europe. Even the country’s strongest banks, such as Santander, the global banking giant, have a fairly risky ratio of 115%, while major Italian banks like UniCredit rely on heavy borrowing to a similar or greater degree.
In the United States, the comparable figure is around 78%, which means that the largest American banks have excess deposits and additional liquidity that they must put to work. (That can pose its own perils, as JPMorgan Chase recently demonstrated with its disastrous trade bets built on excess deposits and loss hedges.)