Europe’s Crippling Risk Aversion

From banks that won’t lend, to savers who won’t buy shares, to the notorious precautionary principle, how Europe’s safety first culture is creating new dangers for a continent facing stagnation

Photo by Erica Nilsson on Unsplash

Latvia, where I have spent a few days this week, may not be the most obvious place to go to ponder the troubles faced by the European economy. But it turns out to be as good a place as any. One of the eurozone’s smallest economies turns out to be the most extreme exemplar of one of the biggest problems holding back the entire bloc: a crippling aversion to risk that permeates the blocs economic and social model. In Latvia this risk aversion is manifested both in a banking system that is barely serving the needs of the domestic economy and the absence of alternative market-based sources of capital to finance investment in promising businesses.

The problem was succinctly spelled out by Martins Kazacs, the Governor of Latvia’s central bank, in his presentation to the conference that he was hosting. He noted that Latvian bank lending amounted to a risible 28 per cent of GDP, far below the eurozone average of 76 per cent. Yet despite this low level of lending, Latvian banks had some of the highest loan charges, lowest bad debt levels and highest margins and returns on capital employed anywhere in the European banking system. 

You would think that in a functioning European single market, such a lucrative market would draw in new entrants eager to take market share whether by offering cheaper loans or by extending credit to those excluded by the incumbents. The loan rejection rate is four time higher in Latvia than the eurozone average. Yet this isn’t happening. Nor is it happening in Latvia’s Baltic neighbours, Lithuania and Estonia, which share many of the same characteristics, the three topping the eurozone banking league tables for return on equity. Why on earth not? 

Before answering that question, it is worth noting why this matters.