1/12/17: Eonia's strange vaulting

What concentration risk and liquidity risk can do to you when both combine?

Eonia (Euro OverNight Index Average) is the 1-day interbank interest rate for the Euro zone. In other words, it is the rate at which banks provide loans to each other with a duration of 1 day (so Eonia can be considered as the 1 day Euribor rate). In other words, it is a measure of short-term liquidity.  Eonia is an average of actual rates charged, so it is, in theory, a reflection of the market demand for short term liquidity. But Eonia is a tiny market, trading normally daily at around EUR7 billion or less. And in a tiny market, there can be a sudden shift in trading volumes. This is what happened on Wednesday and Thursday. Eonia rose from -0.36 basis points on Tuesday to -0.30 bps on Wednesday to -0.24 bps on Thursday.

Eoinia's volumes are 90% direct borrowing by prime banks (and the balance is brokered), so a handful of large institutions use the market to any significant extent. Which induces concentration risk. Worse, Eonia is a secondary/supplementary market, because the ECB currently provides extremely cheap liquidity in unlimited volumes on a weekly basis. Which is another risk to Eonia, as it is thus set to absorb any short term variation in liquidity demand (below 1 week).

Bloomberg speculated that "The most likely explanation is a technical hitch, rather than some sudden crisis warning. The cause of the spike could be a U.S. financial institution that has switched its year-end accounting period from Dec. 31 to Nov. 30. This may have driven a sudden need for short-term liquidity, thereby causing a squeeze. It was month-end for many financial institutions on Thursday, on top of which we are approaching year-end periods, when cash and collateral rates often get squeezed. A bit of indigestion shouldn’t be a surprise. But a move this big is."

If Friday close gets us back toward Tuesday opening levels, the glitch might just be a glitch. If not, something might be happening beyond 'technical' hitches.

The strangest bit is that the move signals a potential liquidity squeeze in a market that has, if anything. too much liquidity. And the matters are not helped by the shallow trading volumes, that imply a concentrated move.

Something to watch, folks, if anything - for just another illustration of the concept of correlated risks.

15/4/16: Banking Union, Competition and Banking Sector Concentration

One of the key changes in recent years across the entire U.S. economy has been growth in market concentration (lower competition) and regulatory burden increases in a number of sector, including banking. A good summary of the matter is provided here: http://www.americanactionforum.org/research/market-concentration-grew-obama-administration/ .

However, an interesting chart based on the U.S. Fed data, shows that even with these changes U.S. banking sector remains relatively more competitive than in other advanced economies:

Source: @HPSInsight

Interestingly, European banks are also becoming more regional, as opposed to global, players as discussed here: http://www.nakedcapitalism.com/2016/03/the-us-is-beginning-to-dominate-global-investment-banking-implications-for-europe.html

Chart next shows market shares of the European Investment Banking markets accruing to banks originating in the following jurisdictions:

Source: @NakedCapitalism

As an argument goes: “Deutsche Bank and Barclays are the only Europeans left in the top seven for the EMEA market. But they are likely to lose their positions because Deutsche Bank is currently undergoing a major reorganisation and Barclays is in the process of executing the Vickers split. In the investment banking field, the only pan-European banks will all soon be American. This has the corollary, for good or bad, that European national and EU-level authorities, such as the European Commission, will have rather less direct control over them. A key part of the European financial system is slipping out of the grasp of the European authorities.”

Which begs two questions:

Does Europe need more regulation-induced consolidation in the sector, aiming to make TBTF European banking giants even bigger and even less diversified globally, as the European Banking Union and European Capital Markets Union, coupled with increasing push toward greater regulatory constraints on Fintech sector are likely to do?

Or does Europe need more disruptive and more agile, as well as risk-diversified, smaller banking systems and more open innovation culture in banking and financial services?


Note: you can see my analysis of the European Capital Markets Union here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2592918