As we travel through the credit crunch era we have the fear that we will repeat the experience of Japan and find ourselves experiencing what has become called the “lost decade” which began in the early 1990s and is still ongoing. We have seen a reminder of that only this morning as the Japanese economy shrunk again (by 1.4% annualised as they measure it) in the last quarter of 2014.This provides the link to today’s topic which is the banks and what we have failed to do. Back in the day when I was knee-high to a grasshopper in financial market terms I worked in Tokyo for a time and continued to work on Japanese issues when I returned to the UK. At that time the health of the Japanese banks was on everyone’s minds and as the Nikkei 225 equity index fell we were told that they were fine at the following levels. It started at 26,000 the 24,000 then 22,000 then 20,000 then 18,000 then 16,000 and so on.
The obvious point is that if there were serious concerns about banking health at an index level of 26,000 then they had to be completely underwater by 20,000. Yet the Japanese establishment preferred to look the other way and in banking terms might have contributed some ideas to the Cranberries.
Zombie, zombie, zombie
The consequences of this were known before the credit crunch as this paper of the Ideas section of the St. Louis Federal Reserve Bank from 2006 confirms.
We start with the well-known observation that most large Japanese banks were only able to comply with capital standards because regulators were lax in their inspections. To facilitate this forbearance the banks often engaged in sham loan restructurings that kept credit flowing to otherwise insolvent borrowers (that we call zombies). Thus, the normal competitive outcome whereby the zombies would shed workers and lose market share was thwarted.
Thus the one thing we needed to avoid in banking terms was to be singing along with The Vapors.
Turning Japanese I think I’m turning Japanese I really think so
Bank share prices
We have seen over the past week or two something of a crisis in the banking sector. What is most revealing is that it has been a crisis of confidence. The catch here is that we have been told that there have been so many reforms and yet people do not believe in them eight years down the road. Not so far of it own lost decade is it.
One clear trigger has been Deutsche Bank of Germany where there have been fears for some time that the “zombie” concept has been at play in its derivative book. This has recently been triggered by concerns over its CoCo bonds and capital leading to its having to issue an official statement and promise to buy some bonds back. Actually the specific fears were wrong but in my view the general ones were correct. Yes banks have raised capital and are stronger in that sense but as RBS keeps showing us every year those that hit trouble keep doing so or more specifically withhold the truth and release it in penny packers. Thus the fear and mistrust cycle begins again just like in Japan.
The Vickers Report
Even Sir John Vickers is showing signs of losing the faith. I have been very critical of his report on UK banking and in a nutshell my critique is based on the fact that it did not fully apply until 2019. Or safely in “the long grass” as the apocryphal civil servant Sir Humphrey Appleby might have put it in the television series Yes Minister. So my critique had two factors. What if we had another banking crisis before it began? Secondly there was plenty of time as memories fade for it to be watered down. Today it would appear that Sir John has woken up to the latter risk. From Vox-EU.
In sum, there are reasons to query the justification for the Bank of England’s apparent policy softening on bank equity requirements.
I cannot confirm if the sound of laughter can be heard from a modern-day Sir Humphrey Appleby in Whitehall! I can confirm however that if he or she is laughing it might be at this bit.
The 3% increment would apply only to ring-fenced banks with assets above £755 billion, 40% of GDP. There are no such banks.
A ring-fenced bank with assets less than £175 billion (about 10% of GDP) would have no systemic risk buffer requirement at all. (Northern Rock in 2007 is a case in point.)
Actually of course there is also likely to be laughter at HM Treasury from the equivalent of the apocryphal Sir Frank. There is a large irony here is we consider this bit.
Meanwhile the markets have something to say. In the early weeks of 2016 bank stocks and related instruments have dropped sharply.
The man whose report was supposed to guard against this sort of thing is afraid of the market moves it was supposed to stop. Oh well, I guess we have an addition to the definition of contagion for my financial lexicon for these times. How long will it be before he finds himself singing along with Shaggy?
Why should she believe me
When I told her it wasn’t me
Yesterday saw one of the pieces on the chess board of global banking game theory fall into place as reported by the BBC.
UK banking giant HSBC has announced it is to keep its headquarters in London.
Such threats were designed as we have discussed on here to weaken banking legislation and it is hard not to conclude they have worked. There is plenty of official cheerleading on this front but I note some may be wondering about the exact motives.
You should have mentioned HSBC didn’t go to Hong Kong/China because Chinese execute criminal bankers (@liarpoliticians)
In fact it has been so successful as a tactic that HSBC has already begun to deploy phase two.
HSBC CEO: Would Move 1k UK Jobs To Paris If UK Leaves EU (@livesquawk).
If Battersea is any guide then there will be plenty of room for the HSBC bankers as there are so many French bankers in London now.
Regular readers will be aware that I have long covered the problems of Italian banks. More recently – as the problems contrary to official promises have got worse and not better – I have suggested that Mario Draghi might be tempted to shuffle the definitions of ECB QE so it can buy some of the “troubled assets”? After all it would be a case of dealing with two birds with one stone for the former supervisor of the Italian banks and head of the Bank of Italy. Someone’s fingerprints are all over this.
Thank you to Beate Reszat for drawing my attention to this earlier today. From Reuters.
The European Central Bank is in talks with the Italian government about buying bundles of bad loans as part of its asset-purchase program and accepting them as collateral from banks in return for cash, the Italian Treasury said.
Who knew the Italian Treasury did humour too?!
The move could give a big boost to a recently approved Italian scheme aimed at helping banks offload some of their 200 billion euros ($225 billion) of soured credit.
No wonder Mario Draghi has been so keen on purchases of Asset Backed Securities! Euro area taxpayers will be rather less keen I suspect when in a much later surprise they are told that there has been a “Surprise,Surprise”. Oh and the word asset may need a substantial redefinition too.
The last fortnight or so has seen banking fears return. As I have written early there are at times tactical issues with the claims but the ongoing problems of banks like RBS and Deutsche show that the strategy is correct. We even have the official denial as ECB President Mario Draghi regularly tells us that European banks are “resilient”. Last time I checked Italy was in Europe. More work for my financial lexicon I think as recall that the Irish banking collapse taught is the true meaning of “innovation”. Oh by the way we have been told over the weekend that the Greek banks are fine too. From Kathimerini.
Greek banks won’t need further recapitalization, ECB’s Nouy says
Meanwhile others seem much off message and warn of “trouble,trouble,trouble”. From Bloomberg.
Johannes Laitenberger, the EU’s director general for competition, said governments “are already pushing the boundaries” of state aid rules by devising special purpose vehicles, funding mechanisms, capital instruments and derivatives. These are designed to “circumvent the basic principle” that financial institutions receiving repeated subsidies should be wound up, he said.