ECB report shows strains in banking sector and impact of crisis ahead of cleanup review

FRANKFURT – The banking system in the 17-country eurozone has shrunk since the global financial crisis hit more than five years ago, and loans make up a smaller part of the sector’s business, the European Central Bank said in a report Monday.

The findings underline some of the problems that European officials face as they try to toughen banking oversight, make their system more resistant to crises and strengthen its ability to support growth by lending to businesses.

The ECB said the size of the banking sector, by assets, fell 12 per cent between 2008 and 2012. That means banks hold that much less on their balance sheets in the form of bonds, investments and loans they have made.

The number of credit institutions fell by 10 per cent, from 2,909 to 2,654, and so did several other measures of the size of the banking system, such as the number of branches and bank workers as a percentage of the population.

Banks are critically important in Europe because they are the main source of the credit that companies need to do business. In the United States, companies are less dependent on banks, obtaining credit from investors through the sale of bonds or other debt securities.

The ECB report covered the period following the onset of a global financial crisis that began when banks were hit with losses on bonds that were based on U.S. mortgages to people with shaky credit. The crisis worsened after the collapse of U.S. investment bank Lehman Brothers in September, 2008. Europe then went through financial turmoil in 2009-2012 due to fears that indebted governments might default on their debts and possibly break up the euro currency.

Meanwhile, the report noted that banks’ holdings now include more debt securities, mainly government bonds. In some cases, they had to acquire such easily sellable assets to meet new regulatory requirements. But government bond holdings tighten banks’ links to government finances — a tie which magnified Europe’s troubles with government debt during the crisis. EU officials are looking for ways to lessen the link.

The findings underline key issues as the ECB begins a yearlong check of the banks’ health. Banks whose finances are too strained to lend are holding back growth. The ECB will try to ferret out hidden losses such as loans that are not being repaid, and identify banks that need a push to strengthen their finances by raising more capital.

The asset check is a major test of the European Union’s credibility, after two earlier attempts by the European Banking Authority to expose weak banks through so-called stress tests fell short in 2009 and 2011. Several banks got passing grades but then needed to be bailed out, suggesting the tests did not get to the bottom of the troubles in the system.