Monday, June 25, 2012

25/6/2012: Thinking outloud: Euro Area Banks Levy

Latest reports suggest the EU leaders are pushing for a 'banking levy' to finance common deposit insurance scheme, a banks resolution fund and joint supervision authority.

It has been my view all along that the former two are required for the financial sector future health and to break the onerous link between the banks and the sovereigns. Alas, I must point out the reality of what such a proposals will mean.

To start with, let's us ask a question: What happens when economy enters a recovery stage from even a cyclical downturn?

Answer: surplus savings built during normal downturn alongside accommodative monetary policies result in an increased supply of capital to finance capex expansion in the private sector. This leads to rising cost of capital on demand side (as demand for capex quickly outstrips supply) and on supply side (as monetary authorities tighten rates into upswing cycle).

But here's a problem, Roger, and it's Europe: suppose the economy is about to take off onto capex growth path:

  • Savings nowhere to be seen as deleveraging of households will be still ongoing
  • Deleveraging of banks, including in anticipation of LTROs expiration means no supply of new credit
  • Policy rates might stay low, but retail rates will remain higher than normal as banks balancesheets remain weak and state or EU-held (via 'resolution' vehicle) equity remains high
  • In the mean time, five years of the crisis have created a massive penned up demand for capital, so market rates will be even higher
  • Equity capital will be scarce, as global recovery will most likely be ongoing, sapping capital into more growth-generative regions, and
  • There's that EU levy as an icing on the cake to add to costs and shrink the margins.
Now, posit the above against the following environment scenario:
  • Households debts are still high, but incomes are now undermined by five years (plus) of a recession and stagnation
  • SMEs and many corproates balancesheets are weak (due to stagnation in exports and internal demand, plus deleveraging costs)
What do you get? Oh, rapid increase in credit costs, leading to more households and business insolvencies. So, go ahead, as Clint The Market would have said, make my day, punk. Raise some more levies...
Post a Comment