20/09/2011: EU banks losing corporate deposits & 'stress tests' scam

In a testament that the world continues to lose confidence in Euro area banking system, Europe's largest engineering firm, Siemens reportedly withdrew large amounts of deposits from the commercial banking system and deposited them with the ECB. The details of this transaction were reported in today's FT (link here) and other media outlets.

In the mean time, WSJ reported that documents distributed at the meeting of the euro area finance ministers in Wroclaw last weekend out to question the validity of the European banking stress tests carried out this summer.


Siemens withdrawal amounted, reportedly to €500 million and impacted "a large French bank", motivated by "concerns about the future financial health of the bank and partly to benefit from higher interest rates paid by the ECB". Again, per reports, Siemens now holds €4-6bn at the ECB, mostly in one-week deposits.

Siemens set up a banking arm almost a year ago to insure itself against adverse risks to liquidity flows in the context of the global financial crisis, enabling it "to tap the central bank for liquidity and deposit cash at the ECB"Siemens does not only use the ECB as a haven; it also gets paid a slightly higher interest rate than it would get from a commercial bank.

ECB, currently amidst sterilized bonds purchasing programme, uses deposit facilities to cut down on money supply increases created by it buying PIIGS bonds. To do this, ECB attracts deposits from commercial banks by offering 15bps margin on its deposits over 0.95% average interest rate for overnight deposits with euro are banks.

In effect, Siemens move kills two birds with one stone - the company achieves greater security of deposits (eliminating counter-party risks) and benefits from 0.15% spread on deposits - a nice sum amounting to €6-9mln per annum, which most likely covers its 'banking' operations costs.

In the severely distorted world of euro area banking, thus, smart corporates can have a decent free lunch, courtesy of ECB's continued insistence on protecting failed sovereigns and banks.


Per WSJ report (link here) EU banks stress tests carried out in July 2011 were based on archaic macroeconomic scenarios that did not cover the latest developments in sovereign credit markets. "The tests did not manage to restore market confidence,"reports WSJ based on the document discussed by finance ministers.

One specific macroeconomic assumption criticised relates to the scenario under which stress is applied to sovereign bond holdings of the banks - the core point of the entire exercise - "a scenario which was clearly taken over by events as months passed by."

So here we have it, folks, our ministers have now admitted what most of us knew all along - the stress tests in 2011 were as shambolic as those in 2010 despite being carried out under the watchful eye of EBA - the 'new' authority that is supposed to make the banks more transparent and better managed post-crisis.

I bet folks at Siemens Bank are glad they didn;t put much faith with euro area banks regulators...

Economics 3/10/10: The real stress in Euro area banks

"A picture's worth a 1,000 words" an old proverb goes. So here's a couple of pictures from the latest GFSR analytical papers issued by the IMF last week:

Remember the favourite EU leadership myth: "The Americans caused this crisis". Ok, if so, one would assume that EU banks are in a better position through the crisis than their US counterparts.
If the assertion above was correct, why would the demand for CB financing be so much greater in the EU both in terms of banks demand for liquidity prior to the crisis and after the crisis?

Charts above are confirmed by the even more dramatically divergent case of the banking sectors exposure to the repo operations:
The magnitude of European banks internal sickness in structuring funding - from their chronic dependence on CB funding even at the times of plentiful liquidity, to their massive exposures to repo operations in general is stunning.

If you want to see the really frightening summary of this analysis, here it is, courtesy of the GFSR:
Notice the disproportional over-reliance of Euro area banks on short-term funding (the infamous maturity mismatch) and non-deposits-based long-term funding (the infamous liquidity and counterparty risk-linked bit). Now, check out the healthy US side of deposits finance - you'd think that the picture should be inverted, given Europe's demographics, but no - heading into the massive explosion of retirement age population in EU, our savings play so much smaller of a role in funding our banks, one must wonder: What happens when German consumers start drawing down their deposits to finance their retirement consumption? Will there be anything else left for the future of the continent other than sales of Mercs and BMWs to China?

Economics 27/7/10: Stress tests of Irish banks? Get real!

An excellent comment on AIB and BofI 'stress tests' results from Peter Mathews, worth a direct post (rather than 'just' a comment) on this blog. Read it here.

Economics 25/7/10: What lending markets tell us about EU policies

So the markets are not that enthused about the stress tests. After the initial bounce on the back of 'pass' grades, there are rising concerns about some 19 banks, including AIB, which were given 'all clear' with some serious stretch of assumptions.

But to see what is really going on behind the scenes, look no further than the actual interbank lending rates. In fact, the interbank lending markets provide a good reflection on the combined euroz one policies enacted since the beginning of the Greek debt crisis. Both euribor (the rate for uncollateralized lending across euro zone's prime banks) and eurepo (lending rates for collateralized loans between euro zone's prime banks) are significantly elevated on twin concerns about:

1. The quality of the borrowing banks (recall - these are prime banks); and
2. The quality of the collateral (with sovereign bonds being top tier quality, deterioration in sovereign debt ratings is hitting interbank markets hard).

Here are the usual, updated charts:

Chart 1Long maturities have been signalling extremely adverse effect of the Euro rescue package since its inception.

Medium-term maturities show severe deterioration since the euro rescue package. Steepest, and uninterrupted rise in 3 months euribor signals that the rescue package is faltering in delivering anything more than a buy-time for the euro… In other words, we have an expensive (€750 billion-sized) buy-in of short time.

The ECB claw back on longer term lending window did not help this process either. But the stress tests are doing nothing to stop the negative sentiment dynamics.

Chart 2Per chart 2 above, short-term maturities are showing that despite supplying underwriting to about a half of the full year worth of euro area bonds refinancing, the rescue package has achieved no moderation in the short-term risk perceptions of the market. In fact, the rise in euribor is more pronounced in the short term than in longer maturities, suggesting that short term risks of sovereign default remain unaddressed by the rescue package and are exerting a continuous pressure on interbank lending.

Introduction of the stress tests also did nothing to reduce overall cost of borrowing amongst the prime banks which were fully expected to pass the test even before the EU got on with setting test parameters.

In turn, all of this spells much higher costs of funding for the banks which have shorter term financing needs, such as the Irish banks. The implicit cost of taxpayers’ guarantee for Irish banks debt is therefore rising.

And panicked markets are not about to surrender their fears to the EU PR machine. With all the increases in the euribor, the volatility of the interbank lending rates also increased, across all maturities, as shown in charts 3 and 4 below.

Chart 3Chart 4As evident, in particular, from chart 4, in the longer term, credit markets are absolutely not buying the combination of the EU rescue package, ECB liquidity measures and the stress tests. Euribor trajectory for maturities of 6 months and higher firmly re-established and vastly exceeded volatility that preceded the pre-rescue panic. We are now worse off in terms of the cost of banks financing than we were before the Greek crisis blew up.


To remind you - eurepo is the rate at which one prime bank lends funds in euro to another prime bank if in exchange the former receives from the latter the best collateral in terms of rating and liquidity within the Eurepo basket. Eurepo rates have posted dramatic increases since mid-June 2010. The original effect of the June 2010 closure of the longer maturity (12 months) ECB discount lending was a temporary reduction in the rates, followed by a stratospheric rise two week later that has been sustained through the end of this week. This is especially true for shorter term maturities, suggesting that part of the adverse effect was due to the heightened uncertainty around the EU stress tests. Chart 5 below illustrates.

Chart 5Chart 6The u-shaped response in the interbank lending rates to ECB lending changes and to stress tests is even better reflected in the longer maturity eurepo rates, as highlighted in chart 6 above.

3-months and 12-months eurepo rates are now at the levels consistent with the height of the sovereign default crisis. There are significant differences in the rates by maturity group and vis-à-vis euribor due to the fact that the quality of collateral offered in the markets is now itself uncertain as sovereign credit quality continues to deteriorate both in terms of increasing probabilities of default and thus associated risk premia, but also due to the regulatory treatment of collateral that is being signalled by the stress tests.

As with euribor, eurepo rates are showing remarkable increases in volatility, for both shorter and longer term maturities.


Let us finally put the two rates side by side to compare evolution of euribor against eurepo, setting index for all at 100=January 4, 2010

Chart 7Chart 8
Some pretty dramatic stuff. To round off, recall that since the beginning of April 2010, the eurozone has undertaken the following measures to shore up its financial markets:

1. Set up a sovereign rescue fund worth more than €750 billion to underpin roughly 50% of the total borrowing requirement in the euro zone (which could have been expected to yeild an improvement in banks collateral and thus a reduction in overall systemic risks in the interbank markets as well);
2. Reduce maturity profile of ECB lending window (which was from the get-go equivalent to dumping more petrol on the forest fire);
3. Deploy aggressive quantitative easing by the ECB (again, this should have reduced uncertainty in the interbank markets as in theory improved pricing for sovereign bonds should have increased the quality of interbank collateral and improve banks own books);
4. Conduct an absolutely discredited stress test of the banks (designed to provide positive newsflow for the banks, especially for prime banks which should have seen their risk profiles reduced by a mere setting up of the test).

In short, none of the measures seem to be working, folks... May be, just may be, the real problem with EU banks is their unwillingness to come clean on loans losses and start honestly repairing their balancesheets?

Economics 20/7/10: EU test - have a Pass grade before you turn up for a check...

Per Bloomberg report today: “Hypo Real Estate Holding AG, the commercial-property and public-finance lender taken over by the German government, failed a Europe-wide banking stress test, two people familiar with the results said.” Crucially, however, “the Munich-based lender is probably the only German bank to fail the test, one person said.”

Makes you wonder – what kind of test is that if out of 91 not exactly rude-health institutions, only one is expected to fail? At an expected 99% success rate, the EU stress test is clearly designed to put a PR spin on banking sector shares, bonds and interbank credit markets.

The only sticky part is that if any of the ‘passed’ banks fail in the near future, the investors should be able to sue the EU for any losses incurred. You see, the EU stress test is designed – at least in theory – to provide important markets-relevant information to investors. If so, someone should be liable for the quality of the test. Had the EU authorities given this a thought?

The test is farcical. And you don’t need to see the results to know this much. European banks are set minimum requirement of 6% Tier 1 capital ratio. This is the number being tested. But the US banks had this requirement 2 years ago, and since then have beefed up their capital ratios to well in excess of 9%. UK banks are now in excess of 10%. Where does this put the Eurozone with its banking system ‘tested’ to 6%? In a circus terminology – with the clowns, large shoes, red noses and curly wigs in place. So the EU regulators’ decision to put some more powder over their mugs wont be doing much good.

FT blogs' Tracy Alloway reported today on what the markets think. The article (linked here) reports that there has been a 50% or more rise in the short positions held against a number of Eurozone banks. Ireland’s sick puppies – BofI and AIB are actually most active on long investors’ lists with long positions up ca 20%. But the two are also amongst the most expensive securities to borrow. In other words, it does seem like shorts are heavily on the side of Ireland Inc’s grand dames.

Funny thing, relating to the stress tests, is that a number of public officials – from Greece, to Belgium to Ireland – have already been leaking heavily the ‘news’ that stress tests will clear their banks’ names. One wonders if there is anything else the EU can do to make the whole exercise even more farcical?

Economics 12/7/10: ECB - cooking up the (banks') books?

Something fishy is going on at the ECB. Having all but destroyed its own reputation (for the n-teenth time), the ECB has swung into its usual modus operandi – ‘We are tightening, tightening no matter what!’ First, in the face of clearly sluggish writedowns by the Euro zone banks, the ECB decided to close its longer-maturity lending window. Despite a clear warning from the Bank for International Settlements stating that there is a worldwide rising risk of a severe maturity mismatch on banks balancesheets.

Now, the ECB is signalling that it will cut government bond purchases – just in time for euribor climbing up and sovereign spreads shooting past their pre-Greek crisis highs. Last Friday, Jürgen Stark said that declining scale of the ECB’s bond markets interventions reflects improving market environment for sovereign bonds. In May the ECB was hovering ca €33bn in bonds per month, last week this has fallen back to €16bn in monthly purchase rates. “If the situation improves further, then there is no need to continue [with bonds purchases]”, he told FT.

Funny thing, the IMF has just urged the ECB not to discontinue bond purchases. But, to Mr Stark “The IMF has not caught up with the reality in Europe.” Oh, poor IMF, apparently a quick reprieve in some credit default swap indices last week (e.g. Markit iTraxx Financial, down 25bp, its largest decline in two months) is not exactly convincing for the IMF as far as prognosis of markets confidence in Europe goes. It looks like either the ECB is betting a house on its own forecasting prowess or setting itself up for another ‘Fool’s stumble’ through monetary policy. Expect bond purchases to resume once the summer is over and the markets re-open for business.

Oh, and just in case you might think that the IMF is really not getting the ECB’s “Europe is Great” vision, here’s the note from the WSJ blog (here) which shows that the ECB will be facing not just a steep sovereign bonds purchase curve, but will be getting more of the Euro area dodgy collateral into its vaults very soon. Apparently, the rest of 2010 through 2011, Euro area banks are facing a mind-blowing level of debt refinancing – the whooping €1.65 trillion worth of stuff. Don’t think they’ll be highlighting that in the shambolic stress-testing PR exercises that will be released July 23. I wrote about Euro zone’s banks propensity to stick their heads into sand when it comes to recognizing loans losses. But now, it also looks like they are doing the same with their funding sources – a dangerous game given the direction in which borrowing rates are going (see my earlier post on euribor).

Here is a nice pic I reproduced from the IMF GFSR database showing those dogs. The tail is wagging, noses are wet, barking mad… furry friends of ECB’s discount window.

I know, I know – Stark would say that the WSJ also ‘doesn’t get Europe’s great progress to prosperity’. But the little problem is – if the banks are to refinance these borrowings at current rates, between 2010 and 2015, Europe’s borrowers, consumers and investors will have to come up with a whooping €152-187 billion worth of interest rate cover. Yes, that’s right – while ECB is playing an outright silly game of ‘We are tough and things are great’, European economies will have to deliver almost 2% of their domestic output to plug interest rate hole alone.

But do not worry, the stress tests deployed by Europe are not designed to reckon with reality – they are simply a PR exercise. How else can one see a test that prices Greek default losses at 10% and Spanish at 3%, when the markets are pricing these at 4 times higher. Or how does one really test the banks if there are no scenarios for loans defaults and/or yield curve tests for debt refinancing?

If you need an indication just how shambolic these tests are, look no further than banks actions in refinancing markets over the last week. Clearly fearing that the investors might, just might, come to their senses and label the whole stress testing a farce, Euro banks have gone aggressively into the markets to raise €18.4bn worth of bonds last week, up from €4.8bn a week before. Do you think they are doing this because of cheaper cost of finance? Not really, costs remain high, though they are off their June peaks. So they are doing this only because they anticipate further increases in the cost going forward.

Yet, the ECB is drumming up the beat that the stress tests will reveal Euro area banks to be well-capitalized (haven’t we heard this before in Ireland? Ca 2008 from our own CB?). So the banks do not believe that the stress tests, which they all pretty much have passed already, per ECB assertions, are going to reduce risks perceptions in the markets. Why would that be the case, if the tests were honestly designed to really test their balancesheets? Last week’s survey of money managers by US-based Ried Thunberg ICAP found that 95% of the 22 survey respondents (controlling $1.39 trillion in assets) said most major European banks will receive positive test ratings.

Hmm… that, I would say, is a darn good evidence that the tests might be rigged. In which case, prepare for a rally in the banks that will turn South as soon as serious analysis of the tests assumptions comes through.