The Eurozone crisis is once again back on everyones mind, as the economies of Italy, Greece, France and even Germany start to slow. Unfortunately, this time around the European Central Bank has not been able to calm markets and the yieldson Greek and French bonds have risen to levels not seen for months as investors jump ship.
Whats more, debt right across the European economic block remains at unsustainably high levels and frosty relations with Russia are nothelping matters. Its now expected that Europe will fall into recession once again bad news for banks that operate within the region.
A European recession will hurt Santander(LSE: BNC). Despite the banks progress in cleaning up its balance sheet over the past five years, the group is still highly exposed to the region and is more than likely to feel the effects of any sustained economic contraction.
While Santander only generates around 26% of its income from Continental Europe, with Spain accounting for about 13% of group profits not including Spanish non-performing loans the state of the banks balance sheet is a concern. Even though management has made solid progress dealing with toxic assets since the financial crisis, risks remain.
At the end of this month, on 26th October, the ECB will publish the results from its most rigorous set of stress tests yet. The tests, which are being carried out by the central banks regulator, the European Banking Authority, demand that banks must prove that they can withstand a simulated three-year period under stress.
During this simulated three-year period, economic output will fall 2.1%, pushing unemployment to 13% and sending house prices down 20% on average.Additionally,the central bank is dredging through historic loans on the balance sheets of the banks under examination.
This process is intended to uncover any risky assets that have previously gone unnoticed. In total, it is estimated that over160,000 credit files across the euro area will be examined by6,000 auditors this is not a small task.
City analysts have already started to speculate about which banks will fail the tests and which will pass. Unfortunately, banks with equity tier 1ratios of less than 10%, under the fully loaded Basel III rules, such as Santander andBarclays PLC(LSE :BARC), may be forced to raise fresh capital as a result of these tests.
Barclays has sought to offset concerns that it will need to raise fresh capital by shedding assets. Specifically, the bank has set up a bad bank to shift toxic assets off of its balance sheet.
Barclays bad bank will eventually sell or run down 116bn of non-core operations, including90bn of investment bank assets and of the groups European retail banking operations. So far this year, a whole host of European banking assets have already been sold off.
All in all then, after cleaning up its balance sheet Barclays looks to be a better investment than Santander.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.