IFR Editor-at-large Keith Mullin
The bank recap picture is slowly becoming clearer but I reckon there are some flaws in the proposals unveiled by EC president Jose Manuel Barroso. In essence, new core Tier 1 capital adequacy requirements are being brought forward to 2012 in a hybrid Basel III arrangement, so that under the current capital regime, banks will have to hit 9% after accounting for market levels on sovereign debt holdings.
Under the proposals, EZ taxpayers will be forcibly and inextricably tied to backstopping banks that fall below minimum core Tier 1 ratios. With the shaky state of government finances throughout the eurozone, that could be a burden too far for some.
The proposals are certainly going Angela Merkel’s way (Sarko is having to fall in behind her on the recap modalities). Banks that fall below 9% will be required to seek capital from the market or, failing that, have capital foisted on them by their governments. Only if the respective government is potless will the EFSF (or more specifically the €500bn ESM, which will kick in in 2012 rather than 2013 as per Germany’s request) step in to provide funds.
The first problem is that market-based solutions to the expected €200bn-plus capital shortfall will not be available. Investors see little, if any, upside, in buying bank equity, which is heavily depressed at the moment. This won’t change in the near term, even less so in light of Barroso’s proposal that banks needing recapitalisation can’t pay dividends. The fact the EC president can’t see the gross contradiction here, and the massive disincentive for investors, speaks volumes about his grasp of the subject.
A problem of being potless
The second problem stems from the first. The fact is that many governments in the eurozone are indeed potless or close to being potless. The additional burden of forcibly having to recapitalise banks that can’t get private investors to fund them will put even more pressure on public finances at precisely the wrong time. And from the perspective of process, I can’t wait to see exactly how governments force banks to take extra capital, particularly if they say they don’t want or need it. Who decides in such cases?
It happened under TARP, but the EU is a complex many-headed beast where consensus on the way forward on anything is nigh on impossible, or at best incredibly time-consuming. This is taxpayers’ money, after all. I wonder how the court of public opinion will judge the notion not only of giving money away to people and institutions hated by the general populace – bankers and banks – but also giving money away to bankers and banks they hate AND which say they don’t want it; it’s an interesting dimension to the moral hazard debate.
The third problem is that there’s unlikely to be much of a market for positions that banks might want to offload if they opt for the deleveraging route and look to reduce risk-weighted assets. Investors will undoubtedly low-ball if huge amounts of paper come on to the market from, effectively, forced sellers.
Net-net, I anticipate a long period of confusion, argument and uncertainty. But even assuming banks do raise their capital adequacy to required levels in the medium term, what are they expected to do with it? The UK government has been attempting to browbeat banks into lending to the real economy, with mixed results. I wonder if, Europe-wide, those banks that have been forced to take government capital will be “required” to lend it out to small businesses to get the economy growing again.
Labyrinthine way to fund growth
It seems a rather circuitous route to fund economic growth. It occurs to me that if governments are hell-bent on micro-managing the sources and channels of finance to such an extent why don’t they just cut out the banks altogether and lend directly to SMEs, with returns paid back to taxpayers?
Banks are going to be loathe to lend during a period of low growth, threatening recession, and while the sovereign debt crisis is raging. Which brings me to the other key point in all of this: having an adequately capitalised banking sector is a good thing but it doesn’t solve the sovereign debt crisis. That’s going to take time.
Greece will get the next bailout tranche – even though it blew the conditions – but creditors are now being steered towards a 30% to 50% haircut. I doubt that even that is going to be enough. When Greece defaults, as it inevitably will, I think it’ll be closer to 70%. Heavy losses for private creditors will create knock-on effects for other peripheral EZ sovereigns, in that the assumption will be that their creditors will also be forced to take hits if governments have to resort to the ESM for funds. This is another investment disincentive and a sure sign that peripheral EZ sovereign debt will continue to be seen as a risk asset with high inbuilt event-risk.
So how will banks fare under these tighter capital levels? It’s not looking good. The EBA’s updated stress tests, based on end-June numbers, assuming market levels for EZ debt and targeting a 7% CT1 ratio, will see dozens of banks fail. Under the original stress tests – ie. no stress applied – 41 banks fell below the 7% floor, including Commerzbank, Deutsche Bank, UniCredit, SG and RBS. A further 23 fell between 7% and 9%, including BNP Paribas, Credit Agricole, Barclays and HSBC.
At such a critical time, I continue to be amazed at how vague, flat, flabby, circular and repetitive most of the comments coming out of the EZ machine are when what we need is firm, decisive action
If you mark to market the piles of sovereign debt sitting on banks’ books, it looks likely that few of the 90+ banks that took part in the original stress tests will come out looking good. I guess the only conclusion to draw is one we already knew: a lot of banks are potentially screwed.
Away from the Barroso plan, I feel I have to comment on the 10-step plan proposed a day or so ago by Eurogroup chairman Jean-Claude Juncker to solve the EZ crisis, the crisis that Jean-Claude Trichet has now classified as “systemic”. At such a critical time, I continue to be amazed at how vague, flat, flabby, circular and repetitive most of the comments coming out of the EZ machine are when what we need is firm, decisive action.
So Juncker is looking for a roadmap towards bank recapitalisation. He also wants a growth programme for struggling countries; stronger regulation of financial markets; a new way to deal with ratings agencies; and a different tone on budgets. He also wants automatic sanctions for wayward governments that fail to hit budget targets [short of full economic union and an EZ-wide economic Czar, impossible], a financial transactions tax, and a bigger haircut for Greek debt.
Juncker… shortened
I mean … fine, but it’s all so, like, well … err … good for you, but at the same time it’s also kind of … pointless. If this is the level of debate and discussion, no wonder investors are voting with their feet and heading for the hills. I can get Juncker’s 10 steps down to five:
1. Recapitalise the banks now.
2. Bail out dodgy governments now.
3. Generate economic growth now.
4. Create a seamless global regulatory framework for the financial markets now.
5. Make everything else OK, now.
There you go. You heard it here first. Let’s see if my radical ideas get me appointed to a cushy tax-free EU job. I’ve got loads more pointless platitudes where those came from.
