IMF published Global Financial Stability
Report update for June 2012, titled “Intense
Financial Risks: Time for Action”
Per report: “Risks to financial
stability have increased since the April 2012 Global Financial Stability Report
(GFSR).
- Sovereign
yields in southern Europe have risen sharply amid further erosion of the
investor base.
- Elevated
funding and market pressures pose risks of further cuts in peripheral euro area
credit.
- The
measures agreed at the recent European Union (EU) leaders’ summit provide
significant steps to address the immediate crisis. Aside from supportive
monetary and liquidity policies, the timely implementation of the recently
agreed measures, together with further progress on banking and fiscal unions,
must be a priority.
- Uncertainties
about the asset quality of banks’ balance sheets must be resolved quickly, with
capital injections and restructurings where needed.
- Growth
prospects in other advanced countries and emerging markets have also weakened,
leaving them less able to deal with spillovers from the euro area crisis or to
address their own home-grown fiscal and financial vulnerabilities.
- Uncertainties
on the fiscal outlook and federal debt ceiling in the United States present a
latent risk to financial stability."
Aside from the headlines, some
interesting points from the report are:
- Market conditions worsened significantly in May and June, with measures of
financial market stress reverting to, and in some cases surpassing, the levels
seen during the worst period in November last year. (see Figure 1)
- The 3-year LTROs
helped support demand for peripheral sovereign debt but that positive effect
has waned. Private capital outflows continued to erode the foreign investor
base in Italy and Spain (see Figures 3 and 4)
An interesting
point on Euro area banking sector [emphasis mine]: “Notwithstanding the ample
liquidity provided by the ECB’s refinancing operations, funding conditions for
many peripheral banks and firms have deteriorated.
Interbank conditions remain strained, with very limited activity in unsecured
term markets, and liquidity hoarding by core euro area banks. Bank bond
issuance has dropped off precipitously, with little investor demand even at
higher interest rates.
“Banks in the euro
area periphery have had to turn to the ECB to replace lost funding support, as
cross-border wholesale funding dried up, and deposit outflows continue. The April 2012 GFSR noted that EU banks are under pressure to cut back
assets, due to funding strains and market pressures, as well as to longer-term
structural and regulatory drivers. The sharp reduction in bank balance sheets
in the fourth quarter of 2011 continued, albeit at a slower pace, in the first
quarter of 2012.
Growth in euro area private sector credit diverged significantly.
While credit has contracted in Greece, Spain, Portugal and Ireland, it has
remained more stable in some core countries.
Survey data on bank lending conditions show that
credit supply remains tight, albeit less so than at the end of 2011, but that
demand has also weakened more recently.
Deleveraging is also a concern for many peripheral
corporations, given their historic dependence on bank funding and the risk that
credit downgrades and diminished investor appetite could drive borrowing costs
higher, even for high credit quality issuers.”
Now, here’s an interesting point not raised in the GFSR, but linked to the above observations:
equities issuance accounts for roughly 55% of total corporate capital in US and
EU. However, because the US corporates issue more bonds-backed debt than their
EU counterparts, banks lending accounts for 40% of the European corporate funds
raised, against 20% in the US. Which means that banks credit is about twice
more important in Europe than in the US in terms of funding corporate capex. In
fact, recent research from BCA clearly links US corporates ability to raise
direct market funding by-passing banks to faster economic recovery in the US
than in EU or Japan.
Add to this equation that European banks are
worse capitalized than their US counterparts and that they are more leveraged
than their US counterparts and you have a bleak prospect for the EU economy.
BCA recently estimated that to bring Euro zone banks’ capital ratios to the
levels comparable with the US average, the largest EU banks will have to raise
some USD900 billion worth of new capital or cut their assets base by a whooping
USD 9 trillion.
But wait, there’s more – you’ve heard about the latest
report in the WSJ that Mario Draghi proposed to bail-in senior bondhodlers in
Spanish banks? Much of the Irish commentary on this was positive, suggesting
that Ireland is now in line for a retrospective deal from the ECB to recover
some of the funds we paid to senior bondholders in Anglo and INBS. Setting
aside the ‘wishful thinking’ nature of such comments – look at Draghi’s idea
implications for EU economic activity. If bail-in does make it to the policy
tool of European authorities, funding for the EA17 banks will only become more
expensive in the medium and long term (risk premium on ‘bail-in probability’),
which, in turn will mean even less credit for corporates, which will mean even
less capex, and thus even lower prospect of recovery.
You know the story – pull one end of the carriage out
of the quicksand pit, the other end sinks deeper… Let me quote BCA: “In Japan,
credit contraction lasted well over nine years in the aftermath of the asset
bubble bust. During that time, deflation prevailed and economic growth averaged
a measly 0.5% annual pace.” Much of hope for Europe then? Not really. Recall
that Japan had aggressive fiscal and monetary policies at its disposal plus
booming global markets when it was undergoing credit bust. We, however, have
psychotic monetary policy, no fiscal policy room and are running debt deflation
cycle amidst global economic slowdown.
IMF is also on the note here: “Policymakers
must resolve the uncertainty about bank asset quality and support the strengthening
of banks’ balance sheets. Bank capital or funding structures in many
institutions remain weak and insufficient to restore market confidence. In some
cases, bank recapitalizations and restructurings need to be pursued, including
through direct equity injections from the ESM into weak but viable banks…”
