Tuesday, March 20, 2012

European Bank Funding and Deleveraging

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

The BIS Quarterly Report, (N. Vause, G. von Peter, M. Drehmann and V. Sushko, March 2012) notes European banks have experienced a liquidity crisis as continued financial deleveraging is placing a fragile recovery at risk, but fail to address long-term solvency issues.

 

European banks experienced extreme pressure to deleverage in late 2011 as funding strains intensified, increasing pressure to sell assets and ration credit as economic activity was weaker. Capital adequacy issues surfaced due to bank sovereign debt exposure.  New regulatory measures requiring banks to meet more stringent capital standards by mid-2012 added to these fears. 

 

European banks did sell certain assets and cut some types of lending, notably those denominated in dollars and those attracting higher risk weights.  This led to government policymaker concerns that the reduced lending would impact real economic activity.  Other credit suppliers (asset managers, other financial institutions & bond investors) helped to mitigate the credit squeeze, so there was little evidence from the BIS of a major impact on lending volumes or asset prices.

 

European central banks introduced special policy measures in December, resulting in improved European banks' funding conditions.  Previously, many banks had been unable to raise funds in the unsecured senior bond market, and the cost of unsecured money market funding had risen to levels previously exceeded only during the 2008 crisis.  Dollar funding had become especially expensive.  Two three-year lending operations (LTRO) by the ECB and a wider set of collateral than was previously eligible relieved much of the stress.  Furthermore, the cost of swapping euros into dollars fell in December, as central banks reduced the costs of their international swap lines.  Short-term borrowing costs then declined and unsecured bond issuance revived.  The view is these measures should limit the impact on financial markets and economic activity. 

 

The measures adopted by the central banks helped to mitigate near-term funding and capital concerns, but the long-term solvency issues remain unresolved.  However, the impact of the central banks’ action remains uneven across the European Union.

 

The massive injections of liquidity by the ECB helped avoid a crisis, there is little evidence that this funding has trickled down to countries and households in the peripheral countries.  The result is the credit contraction in countries such as Portugal and Spain lead to more bankruptcies, even-higher unemployment and a deeper economic contraction that will limit any recovery.  This suggests that ECB actions may provide only temporary relief.

 

The lesson for risk management is that temporary, stop-gap measures are not the best long-term solution and may come at a price.

 

For more information on this follow the link: www.bis.org/press/p120312.htm

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