27/7/15: IMF Euro Area Report: The Sick Land of Banking

The IMF today released its Article IV assessment of the Euro area, so as usual, I will be blogging on the issues raised in the latest report throughout the day. The first post looked at debt overhang.


So here, let's take a look at IMF analysis of the Non-Performing Loans on Euro area banks' balance sheets.

A handy chart to start with:

The above gives pretty good comparatives in terms of the NPLs on banks balance sheets across the euro area. Per IMF: "High NPLs are hindering lending and the recovery. By weakening bank profitability and tying up capital, NPLs constrain banks’ ability to lend and limit the effectiveness of monetary policy. In general, countries with high NPLs have shown the weakest recovery in credit."

Which is all known. But what's the solution? Ah, IMF is pretty coy on this: "A more centralized approach would facilitate NPL resolution. The SSM [Single Supervisory Mechanism - or centralised Euro area banking authorities] is now responsible for euro area-wide supervisory policy and could take the lead in a more aggressive, top-down strategy that aims to:

• Accelerate NPL resolution. The SSM should strengthen incentives for write-offs or debt restructuring, and coordinate with NCAs to have banks set realistic provisioning and collateral values. Higher capital surcharges or time limits on long-held NPLs would help expedite disposal. For banks with high SME NPLs, the SSM could adopt a “triage” approach by setting targets for NPL resolution and introducing standardized criteria for identifying nonviable firms for quick liquidation and viable ones for restructuring. Banks would also benefit from enhancing their NPL resolution tools and expertise." So prepare for the national politicians and regulators walking away from any responsibility for the flood of bankruptcies to be unleashed in the poorly performing (high NPL) states, like Cyprus, Greece, Ireland, Italy, Slovenia and Portugal.
• And in order to clear the way for this national responsibility shifting to the anonymous, unaccountable central 'authority' of the SSM, the IMF recommends that EU states "Improve insolvency and foreclosure systems. Costly debt enforcement and foreclosure procedures complicate the disposal of impaired assets. To complement tougher supervision, insolvency reforms at the national level to accelerate court procedures and encourage out-of-court workouts would encourage market-led corporate restructuring."
• There is another way to relieve national politicians from accountability when it comes to dealing with debt: "Jumpstart a market for distressed debt. The lack of a well-functioning market for distressed debt hinders asset disposal. Asset management companies (AMCs) at the national level could support a market for distressed debt by purchasing NPLs and disposing of them quickly. In some cases, a centralized AMC with some public sector involvement may be beneficial to provide economies of scale and facilitate debt restructuring. But such an AMC would need to comply with EU State aid rules (including, importantly, the requirement that AMCs purchase assets at market prices). In situations where markets are limited, a formula-based approach for transfer pricing should be used. European agencies, such as the EIB or EIF, could also provide support through structured finance, securitization, or equity involvement." In basic terms, this says that we should prioritise debt sales to agencies that have weaker regulatory and consumer protection oversight than banks. Good luck getting vultures to perform cuddly nursing of the borrowers into health.

Not surprisingly, given the nasty state of affairs in Irish banks, were NPLs to fall to their historical averages from current levels, there will be huge capital relief to the banking sector in Ireland, as chart below illustrates, albeit in Ireland's case, historical levels must be bettered (-5% on historical average) to deliver such relief:

Per IMF: "NPL disposal can free up large volumes of regulatory capital and generate significant capacity for new lending. For a large sample of euro area banks covering almost 90 percent of all institutions under direct ECB supervision, the amount of aggregate capital that would be released if NPLs were reduced to historical average levels (between three and four percent of gross loan books) is calculated. This amounts to between €13–€42 billion for a haircut range of between zero and 5 percent, and assuming that banks meet a target capital adequacy ratio of 13 percent. This in turn could unlock new lending of between €167–€522 billion (1.8–5.6 percent of sample countries’ GDP), provided there is corresponding demand for new loans. Due to the uneven distribution of capital and NPLs, capital relief varies significantly across euro area countries, with Portugal, Italy, Spain, and Ireland benefiting the most in this stylized example."

A disappointing feature, from Ireland's perspective, of the above figure is that simply driving down NPLs to historical levels will not be enough to deliver on capital relief in excess of the average (as shown by the red dot, as opposed to red line bands). The reason for this is, most likely, down to the quality of capital held and the impact of tax relief deferrals absorbed in line with NPLs (lowering NPLs via all but write downs = foregoing a share of tax relief).

Stay tuned for more analysis of the IMF Euro area report next.

14/7/2014: Irish Banks are Open for Lending... when no one is looking?

Remember all the Irish banks advertorials in the media about the lending easing they engaged in when it comes to SMEs? The story, as it is being told by the banks, is that our banking system is approving credit to SMEs and that the SMEs just don't apply or don't draw down the loans approved.

Here is IMF chart from today's Euro area survey on the reasons for adverse outcomes of loans applications:

So we have: Irish banks are refusing loans to SMEs at rates second only to Greece. And applications fall short of business expectations at a rate that exceeds that of Greece, so overall, tightness of credit supply to SMEs in Ireland is just as abad as it is in Greece, and worse than in any other 'peripheral' economy.

But never mind, real cost of capital is now back rising in Ireland, so we can expect some additions of grey bars to the above chart too...

All with the blessing of our policymakers who keep talking about higher and higher margins for the banks...

07/03/2014: To sterilise or not to sterilise... ECBs (possible) next dilemma

Yesterday, I was asked by a journalist a question about the possible effects of ECB non-sterilising SMP operations. 

The question was in relation to the measure that has been rumoured as being a part of the ECB’s toolkit under consideration for adoption and it is bound to come up in the next meeting of the GC.

The answer is that we do not know.

Currently, ECB is sterilising around EUR175 billion via weekly operations. Absent such sterilisations, the money will remain within the euro system banks. This is as far as we know. Beyond this point, we can only speculate as to what will happen. 

In normal monetary and balancesheet conditions, banks will lend this money out into the interbank markets, leading to reduced Eonia and, downstream also Euribor, rates. This, in turn, will increase banks willingness to lend to the real economy - businesses and households, but also to purchase government debt. Traditionally, non-sterilised market interventions are seen as an effective tool for increasing money supply in the environment of zero-bound interest rates. And there are good reasons to believe that such a measure would be more effective in raising supply of credit in the euro system than a 25bps cut in the policy rate, as it will likely have a more dramatic effect on Eonia rate and simultaneously flatten the money market curve. Additional benefit of such a measure will be the signal it will send to the markets. Removing requirement to sterilise its SMP, ECB will be signalling that it is open to the traditional QE measures - extending 'whatever it takes' argument from sovereign risk markets (OMT) to the real economy (deflation risks). This too is likely to add liquidity available in the euro system.

However, we are not in a 'normal' monetary and balancesheet environment. Increasing supply of liquidity via non-sterilising SMP can lead to banks substituting away from their normal ECB funding, and as the result, net liquidity supply may not rise by as much as the reduction in sterilisations. 

Two other, longer-term, effects of non-sterilising SMP are: potential loss of credibility and threat to OMT.

By not sterilising SMP, the ECB will signal a major departure from its past commitments, which does not help market confidence in its other commitments, namely the commitment to hold interest rates low over long term horizon. This is a relatively weak argument against non-sterilising of SMP, as all long term monetary policy commitments are only credible as long as underlying fundamentals warrant them. The second point is more salient. ECB committed itself to sterilising not only SMP but also OMT purchases. So far, ECB did not make any OMT purchases, but it already faces stern opposition to OMT from Germany. If ECB signals willingness to break its commitments to sterilisation under SMP, it can send a wrong signal on its commitments to the same under OMT, further putting pressure on ECB to scrap OMT.

Overall, materially, removing requirement to sterilise SMP will, in my view, result in a moderate drop in Eonia and will provide improved supply of credit to the economies that currently do not witness severe credit constraints, such as Germany, where current credit supply conditions are already the most favourable of any period in recent history.

But I doubt that such a measure will have a material impact on peripheral economies due to the general breakdown in the transmission mechanism within the euro area.

Crucially, if ECB opts for non-sterilisation of SMP over the option of lowering policy rates, such a move will not help existent debtors. As the result, non-sterilisation might help where help is least needed and will do little to provide any support for economies with severe corporate and household debt overhang.

Finally, along the longer range expectations, forward-looking agents will be pricing – in the wake of non-sterilisation now – higher uplift in lending rates when monetary policy returns onto normalisation path. In other words, with non-sterilisation today we can expect higher rates in the future, with sharper rises in the rates to long-term trend levels. This too will hurt current borrowers, as lender will be less likely to pass on margins uplifts they will receive if non-sterilisation does deliver reduction in the interbank lending rates.

Note: my view of the lower/reduced effectiveness of non-sterilised interventions is in line with the view held by many researchers and the ECB that we are operating in the environment with broken transmission mechanism. Application of this argument in the OMT case is exemplified here: http://www.cesifo-group.de/DocDL/cesifo1_wp4628.pdf

24/12/2013: Should Government Do More on Credit Supply? Or Do Better?

We commonly hear about the need for the Government to do something about 'credit supply' to the real economy and 'fixing the bad loans' problem in the banks. Alas, as per the IMF assessment shown in the chart below, Ireland is already well ahead of the majority of its euro area counterparts (save Spain and Slovenia) in terms of policies aimed at supporting supply of credit. And we are way ahead of everyone else in terms of policies that are designed to address the issue of bad loans.

Given having policies ≠ having effective policies or allowing policies on the books to be implemented in the real world. So may be the Government shouldn't be 'doing more' to fix credit supply and demand, but instead 'do better'?

Note: Policies aimed at enhancing credit supply include: fiscal programmes on credit (e.g. credit support schemes, etc), supportive financial regulation, capital markets measures (e.g. funding via state agencies etc), and bank restructuring (that the IMF and the Irish Government often confuse for repairing). Supporting credit demand policies include policies aimed at facilitating corporate debt restructuring and household debt restructuring.

30/4/2013: German credit keeps flowing to firms... & still there's no growth

Per German Ifo institute: " Credit constraints for German trade and industry edged downwards by 0.1 percentage points compared to March. Around a fifth of the companies surveyed reported a restrictive credit policy on the part of banks. Despite recent developments in the euro crisis, there have been no significant changes in the favourable financial environment of German companies.

"After last month's decrease, credit constraints for large and small firms rose again, with the latter experiencing the sharpest increase of 1.3 percent. Medium-sized companies reported an easing of credit constraints."

So things are going swimmingly in terms of credit for German enterprises. Ease of getting credit is about as good as 2005-2007 average - the years when German banks were not just lending with abandon to domestic enterprises, but were also funding massive property booms in Spain and Ireland... yet, for all the credit access, German growth is... tanking.

So much for the Irish (and other governments') thesis that if only credit flows were improved, growth will return...

13/8/2012: Euro area ABS markets

Here's a good post on what is happening in the European Asset Backed Securities markets: link.

So much for the hopes of a short-term credit demand & supply recovery... 

2/2/2012: Euro area credit supply remained constrained in Q4 2011

ECB's Bank Lending Survey (BLS) for January 2012 is out, showing dramatic failure of the December 2011 LTRO to kick start supply of credit to the real economy.

According to the BLS, credit standards by euro area banks tightened in the fourth quarter of 2011 on:

• loans to non-financial corporations (35% of euro area banks report tighter lending to NFCs in net terms, up from 16% in  the preceding quarter),
• loans to households for house purchase (29% of the euro area banks reporting net tightening of lending to households, up from 18% in the preceding quarter), and 
• loans for consumer credit (13%, up from 10% in the preceding quarter). 

Looking ahead, euro area banks "expect a further net tightening of credit standards, albeit at a slower pace than in the fourth quarter of 2011" in Q1 2012.  There is no easing of lending conditions on the horizon.

Overall rise in the net tightening  of credit standards was caused by:

• "the adverse combination of a weakening economic outlook" and 
• "the euro area sovereign debt crisis, which continued to undermine the banking sector’s financial position",
• In addition, "increased market scrutiny of bank solvency risks inQ4 2011 is likely to have exacerbated banks’ funding difficulties."

Euro area banks also reported a net decline in the demand for loans to NFCs in Q4 2011, albeit at  a slower pace than in the previous quarter (-5% in net terms, compared with -8% in Q3 2011).

• Banks indicated a sharp fall in the financing needs of firms for their fixed investment. 

The net demand for loans to households  declined further in Q4 2011, "broadly in line with previous expectations and with actual figures quoted in the previous survey round (-27% in the last quarter of 2011, compared with -24% in Q3 2011 for loans for house purchase, and -16% in the last quarter of 2011, compared with -15% in the third quarter for consumer credit).

For Q1 2012 banks expect a sizeable drop in the net demand for housing loans, while the decline in net demand for consumer credit is expected to remain in the same range.

Despite a massive LTRO in December 2011, "euro area banks reported a slight easing of access to wholesale funding in the last quarter of 2011, compared with replies from the previous survey,
although still a large number of euro area banks  (in net terms) continued to report significant
difficulties. ... Looking ahead, banks across the euro area overall expect some improvement  in access to wholesale market funding in the next quarter, potentially reflecting the anticipated effectiveness of non-standard measures taken by the ECB."

Banks also indicated that "sovereign market tensions led to a substantial deterioration of their funding conditions through balance sheet and liquidity management constraints, as well as through other, more indirect, channels. Banks also reported that vulnerabilities to risks stemming from the sovereign  crisis have significantly contributed to the tightening of credit standards, although some parts of the banking system were in a position to shield their lending policies from the impact of the crisis."

"...On the impact of new regulatory requirements on banks’ lending policies, banks’ replies point
to a further adjustment of risk-weighted assets and capital positions during the second half of 2011, to a larger extent than in the first half of the year and more than envisaged in July 2011. The same
applies for the impact of regulation on the net tightening of credit standards. In the coming months
banks indicate a further intensification of balance sheet adjustments and related constraints on the
bank lending channel."