Banks in Europe are still 'fundamentally flawed', says Newton manager

Despite their many shortcomings, the European stress tests have gone some way to ease investors’ considerable fears but Newton manager Raj Shant is not convinced.

Although the reaction of the European market has been one of muted enthusiasm, Shant - who runs Newton and BNY Mellon's Continental European equity funds - believes the regions banks ‘remain fundamentally flawed’.

The European equities specialist said: ‘While these developments have eased investor concerns over sector, and have lessened our negative view of it, we nevertheless maintain an underweight exposure to European banks, and expect to continue to do so for the foreseeable future.’

The rationale behind Shant's defensive positioning is three-fold.

Firstly, he is sceptical on the growth potential of European banks. “We remain cautious about the long-term prospects for profitable lending growth for European banks, because, in simple terms, balance sheet constraints and lack of loan demand will inevitably put pressure on bank growth, with many banks likely to shrink in coming years.’

Shant’s second concern surrounds capital as he believes there is uncertainty on how much risk-bearing capital many of Europe’s banks actually have.

‘While it’s clear that most are sufficiently protected to cope with an economic downturn, would they be able to stand up in the face of a full blown sovereign credit crisis?’

He added: ‘In order to become robust enough to inspire confidence regardless of the headwinds, we believe that large-scale capital raisings are required, and only then could the uncertainty surrounding the sector be eradicated.’

The third reason for caution is liquidity as Shant thinks there is a continued reliance on short-term funding across the banking sector that will have to cease over the next couple of years.

He adds, ‘At present, there is the safety net of ECB funding to fall back on, but this can’t continue forever, and we believe that any reduction in this ‘buffer’ may cause some serious problems for those deposit-poor banks which currently rely so heavily upon it.’

In the past three years the BNY Mellon Continental European Equity fund has outperformed marginally. It has lost 30% compared to a fall of 30.9% in the FTSE Europe ex UK index.