How bad are the European banks?

professore

Pretty bad shape if you consider they had to borrow nearly 1/2 a trillion euro from the ECB ?

Sarkozy said he hoped the banks would buy Spanish and Italian bonds with the money. This looks like QE by the back door.

The Eurozone is beginning to look like Ireland pre bank guarantee. Thoughts?

http://www.msnbc.msn.com/id/45748238/ns/business-world_business/#.TvH6YXqrHIU

FRANKFURT, Germany — The European Central Bank loaned a massive €489 billion ($639 billion) to hundreds of banks for an exceptionally long period of three years to shore up a financial system that is under pressure from the eurozone's government debt crisis.

It was the biggest ECB infusion of credit into the banking system in the 13-year history of the shared euro currency.

Wednesday's loans to 523 banks surpassed the €442 billion ($578 billion) in one-year loans from June, 2009, when the financial system was reeling from the collapse of U.S. investment bank Lehman Brothers.

The ECB is trying to make sure that banks have enough ready cash so they can keep on lending to businesses. Otherwise, a credit crunch could choke off growth and spread the debt crisis to the wider economy through the banks.

Markets rose modestly on the outsized amount of credit support, which was far higher than the €300 billion ($392 billion) expected, but the advance soon faded as the loans highlighted the problems facing Europe's banks. The Stoxx 50 of leading European shares was down 0.4 percent while the euro was trading 0.6 percent lower at $1.3063.

"The good news is, the ECB's efforts to increase liquidity are working," said Jennifer Lee, an analyst at BMO Capital Markets. "The bad news is, high demand for the loans creates worries that banks are urgently in need of funds to boost liquidity ."

Helping the banks may be crucial in the year ahead, as many economists think the eurozone may be headed for recession — figures Wednesday showed Italy, the eurozone's third-largest economy, contracted by 0.2 percent in the third quarter of the year.

Slowing growth would make it even harder for the over-indebted governments that are at the heart of the eurozone's crisis to get a handle on their debt burdens. A recession in Europe would lower tax receipts and make government debt burdens even harder to handle.

A default on debt payments by a country such as Italy or Spain could cause a new financial crisis and send the global economy into a slump.

While the loans support the banking system they do not address the deeper problem of too much government debt and the lack of a financial backstop big enough to assure markets that governments will be able to pay their debts.
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Italy and Spain have been at the center of investor concerns in recent months as their borrowing costs have risen. Those two are considered big to bail out with the current eurozone bailout funds, which have some €500 billion ($654 billion) in financing. Some of that is already committed to bailouts of smaller Greece, Ireland and Portugal, which have all sought outside financial help after default fears drove their borrowing costs so high they could no longer refinance their debts as they came due. Italy has some €1.9 trillion in outstanding debt.

The 37-month term of the loans permits the banks to stock up on money for a much longer period and reduces stress on their finances. Many banks have had trouble borrowing from other banks or by issuing bonds as they do in normal times. That is because lenders fear the banks may suffer losses from the crisis and not pay them back.

Of the €489 billion ($639 billion) loaned out, some 61 percent was rolled over by banks from other ECB credit offerings, meaning about €200 billion ($261 billion) represents new liquidity that wasn't previously in the banking system, according to analysts at the Royal Bank of Scotland. One likely use for at least some of that fresh money is to pay off €230 billion ($301 billion) in bank bonds coming due in the first three months of 2012.

The concern has been that if banks cannot borrow to refinance those obligations they will find the money by cutting back on loans to businesses. Those loans enable businesses to operate day to day, expand their operations and hire people.

There was some speculation that the loans would help governments since banks could borrow money cheap from the ECB operation and buy higher-yielding government bonds.

But many analysts think it is unlikely they will increase their exposure to government bonds amid fears of default. Many banks have cut their holdings of debt from governments that are in financial trouble.

"We still believe it is difficult to reconcile a government desire for banks to continue buying debt with the need for banks to reduce risk exposure associated with government debt," said Chris Walker, an analyst at UBS.

In making the loans, the ECB was playing its role of supplier of liquidity, or ready money to operate with, to banks. That is a typical job for central banks, especially in a crisis.

ECB president Mario Draghi has stressed the central bank's role in supporting the banking system even as it has refused to play that role for the indebted governments themselves by buying large amounts of their bonds.

Draghi says governments must be the ones to reduce their spending and deficits, and should not depend on a central bank bailout.

In contrast to its tough line with governments, the bank has made easy and abundant credit to banks its main tool in dealing with the effects of the eurozone's two-year-old financial crisis.
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Alongside its efforts to shore up the banks, the European Central Bank has also been cutting interest rates to support the ailing eurozone economy. It has reduced its main refinancing rate from 1.5 percent to 1.0 percent over the last two monthly meetings in the hope that lower borrowing costs will stimulate growth by making credit cheaper for businesses.

Under the terms of Wednesday's loans, the banks will pay the average refinancing rate over the three years. The ECB reviews the rate each month and it will almost certainly change. Banks also have the flexibility of repaying the money after a year if their situation improves.

Still, the credit infusion only treats one of the symptoms of the debt crisis. It does not remove the reasons banks remain wary of lending to each other — especially, their thin levels of capital reserves against potential losses. And it doesn't cut the large levels of debt carried by governments.

European officials have said banks need to raise €115 billion ($150 billion) in new capital — but finding that money is not an easy task in the current environment of fear. Investors are leery of putting more money into banks. It would be politically unpopular for governments to do it, and their finances are stressed as well.

pacquiao

professore wrote: »

Pretty bad shape if you consider they had to borrow nearly 1/2 a trillion euro from the ECB ?

Sarkozy said he hoped the banks would buy Spanish and Italian bonds with the money. This looks like QE by the back door.

The Eurozone is beginning to look like Ireland pre bank guarantee. Thoughts?

Who normally buy the government bonds? I'm asking as i here the bond market in every article i read.

professore

pacquiao wrote: »

Who normally buy the government bonds? I'm asking as i here the bond market in every article i read.

Investors, pension funds, etc, i.e. anyone looking for a safe place to invest their money. That's why government bonds normally return very low rates of interest as they are seen as a safe bet. Not anymore in many European countries - some of them, especially Greek bonds are seen as more risky than the likes of Iraqi, Egyptian (post revolution!) and Indonesian bonds.

pacquiao

professore wrote: »

Investors, pension funds, etc, i.e. anyone looking for a safe place to invest their money. That's why government bonds normally return very low rates of interest as they are seen as a safe bet. Not anymore in many European countries - some of them, especially Greek bonds are seen as more risky than the likes of Iraqi, Egyptian (post revolution!) and Indonesian bonds.

Do governments need to borrow from these investors,pension funds etc?

professore

pacquiao wrote: »

Do governments need to borrow from these investors,pension funds etc?

Yes. Instead of borrowing they issue a bond. This is a piece of paper that promises if you give them money now you get it back with interest after a fixed period of time. I'm no expert but if you play the video game Sim City that's how it works there

In fact I am sure you can buy government bonds yourself if you're interested.

later12

professore wrote: »

Pretty bad shape if you consider they had to borrow nearly 1/2 a trillion euro from the ECB ?

Yes that's no secret, Europe is possibly in a credit crunch, or still on the verge of one. Funding pressure on the European banks is enormous, and while this may not avert a credit crunch, Europe would probably be a lot worse off without this 3 year funding. The last thing the bloc needs now is a domino banking crisis.

Sarkozy said he hoped the banks would buy Spanish and Italian bonds with the money. This looks like QE by the back door.

Well he shouldn't.

He should be hoping that the banks will inject that money into the consumer economies instead.

However, purchasing profitable liquid securities like Spanish & Italian debt is the second-best use for this funding (a roundabout way of the improving European banks' balance sheets as well as protecting the weaker sovereigns).

And yes, of course it is a form of Quantitative Easing.

The Eurozone is beginning to look like Ireland pre bank guarantee. Thoughts?

Not really. Why do you suggest that?

pacquiao

professore wrote: »

Yes. Instead of borrowing they issue a bond. This is a piece of paper that promises if you give them money now you get it back with interest after a fixed period of time. I'm no expert but if you play the video game Sim City that's how it works there

In fact I am sure you can buy government bonds yourself if you're interested.

Where would they borrow instead of issuing bonds?

professore

later10 wrote: »

Not really. Why do you suggest that?

From 2005 on, the Irish banks had to borrow massive amounts of money from the ECB and continue to do so.

professore

pacquiao wrote: »

Where would they borrow instead of issuing bonds?

The so called Troika are lending Ireland, Greece and Portugal money right now since no-one else will, or at least at any kind of favourable interest rate.

later12

professore wrote: »

From 2005 on, the Irish banks had to borrow massive amounts of money from the ECB and continue to do so.

2005? From memory, the ECB only started detailing its emergency funding last year, do you have a link?

I'm not really sure what your overall suggestion is here? That Europe is on the brink of recession and a credit crunch? This is widely accepted.

pacquiao

professore wrote: »

The so called Troika are lending Ireland, Greece and Portugal money right now since no-one else will, or at least at any kind of favourable interest rate.

So instead of the pension funds,investors, etc giving us credit the European Commission (EC), the International Monetary Fund (IMF), and the European Central Bank (ECB) are buying our bonds.
In normal times. Why do we need to borrow from the bond markets?

professore

later10 wrote: »

2005? From memory, the ECB only started detailing its emergency funding last year, do you have a link?

I'm not really sure what your overall suggestion is here? That Europe is on the brink of recession and a credit crunch? This is widely accepted.

I'm suggesting Europe is on the cusp of sovereign defaults from Italy and Spain, then France and potentially even Germany. Only problem is they have no one to bail them out.

http://sgcbusiness.com/2008/03/26/irish-banks-borrowed-e394bn-from-ecb-in-2007/

Irish banks borrowed €39.4bn from the European Central Bank in 2007. This is 45% higher than the total amount borrowed in 2006.

I remember reading somewhere else that the Irish banks ran out of their own deposits in 2005. That's when the problems began.

professore

pacquiao wrote: »

So instead of the pension funds,investors, etc giving us credit the European Commission (EC), the International Monetary Fund (IMF), and the European Central Bank (ECB) are buying our bonds.
In normal times. Why do we need to borrow from the bond markets?

The same reason anyone borrows - to spend more money than you have.

later12

professore wrote: »

I remember reading somewhere else that the Irish banks ran out of their own deposits in 2005. That's when the problems began.

Banks routinely borrow from central banks. That in itself is not a problem.

This credit makes sovereign defaults less immediately likely, and not more so, since the most likely recipients of it are peripheral Eurozone states.

-Borrow money from ECB at outrageously low rate
-Buy Italian debt at outrageously high yield
-Profit!

pacquiao

professore wrote: »

The same reason anyone borrows - to spend more money than you have.

What other choices do we have in that regards? Do we have to borrow?

professore

later10 wrote: »

Banks routinely borrow from central banks. That in itself is not a problem.

This credit makes sovereign defaults less immediately likely, and not more so, since the most likely recipients of it are peripheral Eurozone states.

-Borrow money from ECB at outrageously low rate
-Buy Italian debt at outrageously high yield
-Profit!

Where will the Italian government get the money to pay back the bonds when they fall due? Oh wait I see it - they issue more bonds, which the banks buy again, repeating the cycle. :eek: There's a name for that - pyramid scheme.

professore

pacquiao wrote: »

What other choices do we have in that regards? Do we have to borrow?

Cut waste in the public sector. Cut PS pay, fire PS staff, cut social welfare, cut hospitals, close schools, and/or raise taxes. Cutting costs would be much more effective than raising taxes since raising taxes means people spend less, further depressing the economy. However cutting PS spending is not a silver bullet either and creates its own problems.

We could balance our budget, but it would hurt like hell.

later12

professore wrote: »

Where will the Italian government get the money to pay back the bonds when they fall due? Oh wait I see it - they issue more bonds, which the banks buy again, repeating the cycle. :eek: There's a name for that - pyramid scheme.

No.

The idea is that the issuer of the debt, say Italy, decreases their deficit whilst, ideally, allowing its economy to grow.

It's more of an exercise in buying time to get their house in order.

Scofflaw

professore wrote: »

Where will the Italian government get the money to pay back the bonds when they fall due? Oh wait I see it - they issue more bonds, which the banks buy again, repeating the cycle. :eek: There's a name for that - pyramid scheme.

Not really - it's just part of the circulation of money. Which is more akin to a juggling act - or perhaps find the lady, on the basis that as long as the cups keep shuffling, the pea is notionally in all three places, but when they stop, it has to be under just one (or none).

cordially,
Scofflaw

Permabear

This post has been deleted.

hmmm

The ECB was issuing 3 year debt at 1% - it was ridiculously cheap money, of course banks filled their boots with it. It's yet another exercise in buying time which allows banks and governments to get their houses in order, and there's nothing wrong with that.

Solair

professore wrote: »

Investors, pension funds, etc, i.e. anyone looking for a safe place to invest their money. That's why government bonds normally return very low rates of interest as they are seen as a safe bet. Not anymore in many European countries - some of them, especially Greek bonds are seen as more risky than the likes of Iraqi, Egyptian (post revolution!) and Indonesian bonds.

Which just shows how completely insane the markets are! Greece is absolutely not riskier than Iraq or Egypt in reality. It's just hype, hype and more hype.

These are the same markets and rating agencies that a few years ago were telling us that mortgage derivative products were AAA+++

liammur

professore wrote: »

Pretty bad shape if you consider they had to borrow nearly 1/2 a trillion euro from the ECB ?

Sarkozy said he hoped the banks would buy Spanish and Italian bonds with the money. This looks like QE by the back door.

The Eurozone is beginning to look like Ireland pre bank guarantee. Thoughts?

http://www.msnbc.msn.com/id/45748238/ns/business-world_business/#.TvH6YXqrHIU

FRANKFURT, Germany — The European Central Bank loaned a massive €489 billion ($639 billion) to hundreds of banks for an exceptionally long period of three years to shore up a financial system that is under pressure from the eurozone's government debt crisis.

It was the biggest ECB infusion of credit into the banking system in the 13-year history of the shared euro currency.

Wednesday's loans to 523 banks surpassed the €442 billion ($578 billion) in one-year loans from June, 2009, when the financial system was reeling from the collapse of U.S. investment bank Lehman Brothers.

The ECB is trying to make sure that banks have enough ready cash so they can keep on lending to businesses. Otherwise, a credit crunch could choke off growth and spread the debt crisis to the wider economy through the banks.

Markets rose modestly on the outsized amount of credit support, which was far higher than the €300 billion ($392 billion) expected, but the advance soon faded as the loans highlighted the problems facing Europe's banks. The Stoxx 50 of leading European shares was down 0.4 percent while the euro was trading 0.6 percent lower at $1.3063.

"The good news is, the ECB's efforts to increase liquidity are working," said Jennifer Lee, an analyst at BMO Capital Markets. "The bad news is, high demand for the loans creates worries that banks are urgently in need of funds to boost liquidity ."

Helping the banks may be crucial in the year ahead, as many economists think the eurozone may be headed for recession — figures Wednesday showed Italy, the eurozone's third-largest economy, contracted by 0.2 percent in the third quarter of the year.

Slowing growth would make it even harder for the over-indebted governments that are at the heart of the eurozone's crisis to get a handle on their debt burdens. A recession in Europe would lower tax receipts and make government debt burdens even harder to handle.

A default on debt payments by a country such as Italy or Spain could cause a new financial crisis and send the global economy into a slump.

While the loans support the banking system they do not address the deeper problem of too much government debt and the lack of a financial backstop big enough to assure markets that governments will be able to pay their debts.
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Italy and Spain have been at the center of investor concerns in recent months as their borrowing costs have risen. Those two are considered big to bail out with the current eurozone bailout funds, which have some €500 billion ($654 billion) in financing. Some of that is already committed to bailouts of smaller Greece, Ireland and Portugal, which have all sought outside financial help after default fears drove their borrowing costs so high they could no longer refinance their debts as they came due. Italy has some €1.9 trillion in outstanding debt.

The 37-month term of the loans permits the banks to stock up on money for a much longer period and reduces stress on their finances. Many banks have had trouble borrowing from other banks or by issuing bonds as they do in normal times. That is because lenders fear the banks may suffer losses from the crisis and not pay them back.

Of the €489 billion ($639 billion) loaned out, some 61 percent was rolled over by banks from other ECB credit offerings, meaning about €200 billion ($261 billion) represents new liquidity that wasn't previously in the banking system, according to analysts at the Royal Bank of Scotland. One likely use for at least some of that fresh money is to pay off €230 billion ($301 billion) in bank bonds coming due in the first three months of 2012.

The concern has been that if banks cannot borrow to refinance those obligations they will find the money by cutting back on loans to businesses. Those loans enable businesses to operate day to day, expand their operations and hire people.

There was some speculation that the loans would help governments since banks could borrow money cheap from the ECB operation and buy higher-yielding government bonds.

But many analysts think it is unlikely they will increase their exposure to government bonds amid fears of default. Many banks have cut their holdings of debt from governments that are in financial trouble.

"We still believe it is difficult to reconcile a government desire for banks to continue buying debt with the need for banks to reduce risk exposure associated with government debt," said Chris Walker, an analyst at UBS.

In making the loans, the ECB was playing its role of supplier of liquidity, or ready money to operate with, to banks. That is a typical job for central banks, especially in a crisis.

ECB president Mario Draghi has stressed the central bank's role in supporting the banking system even as it has refused to play that role for the indebted governments themselves by buying large amounts of their bonds.

Draghi says governments must be the ones to reduce their spending and deficits, and should not depend on a central bank bailout.

In contrast to its tough line with governments, the bank has made easy and abundant credit to banks its main tool in dealing with the effects of the eurozone's two-year-old financial crisis.
Advertise | AdChoices

Alongside its efforts to shore up the banks, the European Central Bank has also been cutting interest rates to support the ailing eurozone economy. It has reduced its main refinancing rate from 1.5 percent to 1.0 percent over the last two monthly meetings in the hope that lower borrowing costs will stimulate growth by making credit cheaper for businesses.

Under the terms of Wednesday's loans, the banks will pay the average refinancing rate over the three years. The ECB reviews the rate each month and it will almost certainly change. Banks also have the flexibility of repaying the money after a year if their situation improves.

Still, the credit infusion only treats one of the symptoms of the debt crisis. It does not remove the reasons banks remain wary of lending to each other — especially, their thin levels of capital reserves against potential losses. And it doesn't cut the large levels of debt carried by governments.

European officials have said banks need to raise €115 billion ($150 billion) in new capital — but finding that money is not an easy task in the current environment of fear. Investors are leery of putting more money into banks. It would be politically unpopular for governments to do it, and their finances are stressed as well.

Investors of Irish banks, IL&P and BOI were treated disgracefully, IL&P have CT1 of 23%, and wipe equity holders out by 99%. There has to be a fairer way of doing it.

GSF

Solair wrote: »

Greece is absolutely not riskier than Iraq or Egypt in reality. It's just hype, hype and more hype.

I'm not sure how you can say that. It depends on the expectation of getting paid back - not defaulting. Are you saying that Eygpt and Iraq are borrowing at an even more unsustainable level than Greece?

ninty9er

later10 wrote: »

Yes that's no secret, Europe is possibly in a credit crunch, or still on the verge of one. Funding pressure on the European banks is enormous, and while this may not avert a credit crunch, Europe would probably be a lot worse off without this 3 year funding. The last thing the bloc needs now is a domino banking crisis.

Well he shouldn't.

He should be hoping that the banks will inject that money into the consumer economies instead.

However, purchasing profitable liquid securities like Spanish & Italian debt is the second-best use for this funding (a roundabout way of the improving European banks' balance sheets as well as protecting the weaker sovereigns).

And yes, of course it is a form of Quantitative Easing.

Not really. Why do you suggest that?

Does that not make the forced sale of profitable subsidiaries by Irish banks counter intuitive?

Scofflaw

ninty9er wrote: »

Does that not make the forced sale of profitable subsidiaries by Irish banks counter intuitive?

It seems so, but the problem is not that the banks are not profitable - they are profitable - but that they have too many loans in relation to their capital. The profitable subsidiaries will be sold as loan books rather than capital, thus reducing the overall amount of loans held by the banks.

cordially,
Scofflaw

later12

ninty9er wrote: »

Does that not make the forced sale of profitable subsidiaries by Irish banks counter intuitive?

Perhaps; the sale of profitable subsidiaries can negatively affect a bank's long term profitability.

However, it is the regulatory capital requirement which really concerns investors and governments at the moment, so banks are forced to get rid of illiquid capital even if it is profitable and even if it does enjoy a high asset quality (e.g. the sale of Bank Zachodni by AIB).

In place they are encouraged to buy highly liquid securities as can sustain losses in an emergency, and in theory lower the need for official intervention.

In terms of the Irish Banks, my understanding is that under EU competition law they were required to partly raise their own capital as opposed to merely accepting official handouts, which was why we kept hearing that the Minister for Finance would 'seek approval' from EU authorities before capital injections would take place.

antoobrien

professore wrote: »

In fact I am sure you can buy government bonds yourself if you're interested.

Prize bonds (effectively a 3 month bond) as well as the various state savings schemes (run by the NTMA) are all government bonds.

hmmm

There was an interesting piece in the New York Times on this
http://www.nytimes.com/2011/12/22/business/a-central-bank-doing-what-central-banks-do.html?_r=1&hp

It turns out that may be enough to stem the European crisis for at least a few years, and go a long way to recapitalizing banks in the process.

It now seems obvious that this was what Mr. Draghi had in mind. Spain and Italy will be able to borrow money from the market at rates they can live with, but this move is unlikely to have much effect on long-term rates. If those stay high, the pressure for austerity, as Germany demands, will remain.

Duiske

I'm pretty clueless when it comes to financial matters, but would it be possible for AIB, which is basically under state control, to borrow funds from the ECB at 1% and loan it to the State at, say 1.5% ? I can see that there might be a major pitfall if the State finances worsened to the point that it could not afford to pay back AIB, causing the bank to collapse and heaping even more debt on the State due to the bank guarantee scheme. Aside from any potential pitfalls, would it be technically possible ?

hmmm

Duiske wrote: »

Aside from any potential pitfalls, would it be technically possible ?

In many ways, that is the likely outcome of what the ECB has just done, which is why it is being seen as government funding by the backdoor. The banks will borrow money at 1%, and many will use the funds to buy government debt which is trading at higher rates.

later12

Duiske wrote: »

I'm pretty clueless when it comes to financial matters, but would it be possible for AIB, which is basically under state control, to borrow funds from the ECB at 1% and loan it to the State at, say 1.5% ?

That's essentially what is happening, except they're not lending the money at 1,5%, the banks are going into the secondary market and buying up European sovereign debt, lowering the yield.

There are a number of basic reasons for this.

(1)It is in our own best interest to clean up the European banks' balance sheets and see them return to profitability. If they lent the PIGS money, the PIGS would still be left with a plethora of dodgy banks needing requiring state supports. When they succeed, we succeed. When they fail, we fail.

(2)What would be the sense in withdrawing from troika support simply to access short term (3 year) funding for as long as the LTRO operations are open at current levels? At things stand, we have a far more extended 'amortization' schedule for our official debt, at more certain interest rates.

(3) Engagement with the official institutions (the troika) sends an important, transparent, message to the markets that Ireland (and arguably the PIGS) is engaging with internal reform.

(4) A bank cannot simply forego profit and its duty to its shareholders, it has a duty to return itself to profitability, not to help the state out of some debt of gratitude.

(5) If the PIGS were not engaging with the troika (i.e. borrowing from the EFSF-ESM, ESM, IMF & being investigated by the Commission) there is no way the ECB would finance the financial institutions in LTRO