Will Frankfurt or Paris Replace London as the EU’s Leading Financial Center?
Frankfurt and Paris are in a competition to replace London as the European Union’s premier financial center in a post-Brexit EU. But given significant political and financial challenges for the Eurozone in 2017, it seems unlikely that Frankfurt and Paris will succeed in replacing London as the EU’s premier financial center.
Currently, London is far ahead of its continental peers in the global competition to attract companies and banks. 40% of global companies with European headquarters calls London their home. In comparison, only 8% and 3% of companies call Paris and Madrid their homes. Frankfurt does not even feature in the top nine European cities.
Firms based in the United Kingdom manage asset profiles of roughly $6.7 trillion, greater than the combined gross domestic products of Germany and France. Given London’s prominence in European finances, it is all too understandable that Frankfurt and Paris would like to benefit from a London outside of the EU. Yet, financial and political uncertainties loom large in the Eurozone—from Germany’s imminent banking crisis to Italy’s constitutional referendum. Those concerns should make companies reflect deeply before relocating parts of their business operations from London to the Eurozone.
The current crisis in Deutsche Bank, Germany’s oldest and largest bank, poses a huge threat to the Eurozone’s financial stability. It is severely undercapitalized and since last November, its shares are down by 49.2%. According to the International Monetary Fund (IMF), Deutsche Bank, which accounts for 50 percent of Germany’s GDP, is the single biggest threat to the global economy.
Despite the risk that they pose to the economy, German political leadership has been slow to resolve its banking problems. Chancellor Merkel, in particular, has refused so far to bail-out Deutsche Bank. Yet, Germany can ill-afford further deteriorating of the banking crisis, which is likely to slow down Germany’s economy and reduce its standing as the EU’s de facto leader.
However, even if Merkel does decide to bail-out Deutsche Bank, it poses yet another political problem challenge. Bailing out Deutsche Bank with taxpayer money will be a politically unpopular move for Merkel, particularly in light of Germany’s federal election in 2017. Already weakened by her role in the migrant crisis, Merkel cannot afford further weakening of her political reputation.
However, it is not only Germany whose economy is in trouble. Italy is experiencing its worst banking crisis in recent memory. Italian banks are severely undercapitalized, with roughly 18% of all banking loans in Italy non-performing. Even U.S. banks, at the height of financial crisis in 2008, had a non-performing loan share of only 7%.
Furthermore, Italy’s government holds 11% of the Italian system’s banking assets. But the Italian government itself is fiscally unstable, with a debt to GDP ratio of 133 percent. In the EU, this ratio is second only to Greece. But unlike Greece, Italy is the third largest economy in the EU, and as such, Italian banks, like German ones, pose an outsized risk to the rest of the EU economy. Five percent of total banking assets in France are exposed to Italian debt. Because of this exposure, Italy’s bad debts pose significant contagion risks to the rest of the Eurozone.
In addition to economic risks, Italy’s political prospects look bleak. The Italian constitutional referendum is scheduled on December 4th, which the Italian Prime Minister Renzo has a high chance of losing. Encouraged by Brexit, Pepo Grillo of the populist Five Star Party and Matteo Salvini would like Italy to leave the EU. Given Italy’s integral role in the EU, an Italian exit might jeopardize the entire European project.
In light of recent financial and political uncertainties, investors have been pessimistic about the EU’s financial prospects. Since November last year, Germany’s Euro Stoxx 50 and France’s CAC 40 have declined by 11% and 8% respectively. In comparison, the UK’s FTSE 250 went up by 4.96%. As such, it seems unlikely that either banks or investors will be keen to trade Brexit-induced uncertainty in London for even greater uncertainty in the Eurozone.
In order to reduce political and financial uncertainties, EU leaders must focus on recapitalizing Italian and German banks, and convince the Italians not to leave. Until then, it is unlikely that the EU will be successful in its desire to replace London, by Paris or Frankfurt, as Europe’s premier financial center.