What's going on?
Stocks of European banks had one of their worst days of the year on Tuesday – on average, they were down almost 5%.
What does this mean?
On Friday, Italy’s Banca Monte dei Paschi di Siena (BMPS) announced plans to sell off the rights to many loans that it had previously made (i.e. the borrowers would owe the money to someone else). Because the loans are unlikely to get paid back in full, they will be sold at a big discount to the value of the IOU (a.k.a. the “face value” of the loans). For example, BMPS will get paid €0.30 for a loan that’s supposedly worth €1.00. This has led to fears that other Italian banks also need more cash from investors to cover the losses from all their “bad loans.”
Europe’s banking woes were further compounded by Commerzbank, the major German bank, which said that it will make less money this year than it expected. It blamed negative interest rates (which means banks make lower returns from lending money) and sluggish economic growth (which usually means people and businesses don’t borrow as much money).
Why should I care?
For markets: (Most) European banks are in a pickle.
Many banks, especially in Italy, have made loans that are not going to get paid back. Banks in safer countries, like Germany, are struggling to make a profit partly because of the low interest rates. Low profits + bad loans = a big problem for Europe’s banks.
The bigger picture: The problem could become political.
The Italian government would like to give its banks money, but European Union (EU) rules limit its ability to do so. In Germany, the low interest rate environment is causing problems for banks as well as pension funds and ordinary people (who would like higher returns on their investments). It’s not difficult to imagine how this can breed resentment towards the EU – it’s when such threats to the system appear that investors worldwide start paying close attention.