A blog from my late father about the banks

The opening today is brought to you by my late father. You see he was a plastering sub-contractor who was a mild man but could be brought to ire by the subject of how he had been treated by the banks. He used to regale me with stories about how to keep the relationships going he would be forced to take loans he didn’t really want in the good times and then would find they would not only refuse loans in the bad but ask for one’s already given back. He only survived the 1980-82 recession because of an overdraft for company cars he was able to use for other purposes which they tried but were unable to end. So my eyes lit up on reading this from the BBC.

Banks have been criticised by firms and MPs for insisting on personal guarantees to issue government-backed emergency loans to business owners.

The requirement loads most of the risk that the loan goes bad on the business owner, rather than the banks.

It means that the banks can go after the personal property of the owner of a firm if their business goes under and they cannot afford to pay off the debt.

Whilst borrowers should have responsibility for the loans these particular ones are backed by the government.

According to UK Finance, formerly the British Bankers Association, the scheme should offer loans of up to £5m, where the government promises to cover 80% of losses if the money is not repaid. But, it notes: “Lenders may require security for the facility.”

In recent times there has been a requirement for banks to “Know Your Customer” or KYC for short. If they have done so then they would be able to sift something of the wheat from the chaff so to speak and would know which businesses are likely to continue and sadly which are not. With 80% of losses indemnified by the taxpayer they should be able to lend quickly, cheaply and with little or no security.

For those saying they need to be secure, well yes but in other areas they seem to fall over their own feet.

ABN AMRO Bank N.V. said Thursday that it will incur a significant “incidental” loss on one of its U.S. clients amid the new coronavirus scenario.

The bank said it is booking a $250 million pretax loss, which would translate into a net loss of around $200 million.

Well we now know why ABN Amro is leaving the gold business although we do not know how much of this was in the gold market. Oh and the excuse is a bit weak for a clearer of positions.

ABN AMRO blamed the loss on “unprecedented volumes and volatility in the financial markets following the outbreak of the novel coronavirus.”

Returning to the issue of lending of to smaller businesses here were the words of Mark Carney back as recently as the 11th of this month when he was still Bank of England Governor.

I’ll just reiterate that, by providing much more flexibility, an ability to-, the banking system has been put in
a position today where they could make loans to the hardest hit businesses, in fact the entire corporate
sector, not just the hardest hit businesses and Small and Medium Sized enterprises, thirteen times of
what they lent last year in good times.

That boasting was repeated by the present Governor Andrew Bailey. Indeed he went further on the subject of small business lending.

there’s a very clear message to the banks-, and, by the way, which I think has been reflected in things that a number of the banks have already said.

Apparently not clear enough. But there was more as back then he was still head of the FCA.

One of the FCA’s core principles for business is treating customers fairly. The system is now, as we’ve said many times this morning, in a much more resilient state. We expect them to treat customers fairly. That’s what must happen. They know that. They’re in a position to do it. There should be no excuses now, and both we, the Bank of England, and the FCA, will be watching this very
carefully.

Well I have consistently warned you about the use of the word “resilient”. What it seems to mean in practice is that they need forever more subsidies and help.

On top of that, we’re giving them four-year certainty on a considerable amount of funding at the cost of
bank rate. On top of that, they have liquidity buffers themselves, but, also, liquidity from the Bank of
England. So, they are in that position to support the economy. ( Governor Carney )

Since then they can fund even more cheaply as the Bank Rate is now 0.1%.

Meanwhile I have been contacted by Digibits an excavator company via social media.

Funding For Lending Scheme was crazy. We looked at this to finance a new CNC machine tool in 2013. There were all sorts of complicated (and illogical) strings attached and, at the end of the day, the APR was punitive.

I asked what rate the APR was ( for those unaware it is the annual interest-rate)?

can’t find record of that, but it was 6% flat in Oct 2013. Plus you had to ‘guarantee’ job creation – a typical top-down metric that makes no sense in SME world. IIRC 20% grant contribution per job up to maximum of £15k – but if this didn’t work out you’d risk paying that back.

As you can see that was very different to the treatment of the banks and the company was worried about the Red Tape.

The grant element (which theoretically softened the blow of the high rate) was geared toward creating jobs, but that is a very difficult agreement (with teeth) to hold over the head of an SME and that contribution could have been clawed back.

Quantitative Easing

There is a lot going on here so let me start with the tactical issues. Firstly the Bank of England has cut back on its daily QE buying from the £10.2 billion peak seen on both Friday and Monday. It is now doing three maturity tranches ( short-dated, mediums and longs) in a day and each are for £1 billion.

Yet some still want more as I see Faisal Islam of the BBC reporting.

Ex top Treasury official @rjdhughes

floated idea in this v interesting report of central bank – (ie Bank of England) temporarily funding Government by buying bonds directly, using massive increase in Government overdraft at BoE – “ways & means account”

Some of you may fear the worst from the use of “top” and all of you should fear the word “temporarily” as it means any time from now to infinity these days.

This could be justified on separate grounds of market functioning/ liquidity of key markets, in this case, for gilts/ Government bonds. There have been signs of a lack of demand at recent auctions…

Faisal seems unaware that the lack of demand is caused by the very thing his top official is calling for which is central bank buying! Even worse he seems to be using the Japanese model where the bond market has been freezing up for some time.

“more formal monetary support of the fiscal response will be required..prudent course of action is yield curve control, where Bank can create fiscal space for Chancellor although if tested this regime may mutate into monetary financing”

Those who have followed my updates on the Bank of Japan will be aware of this.

Comment

Hopefully my late father is no longer spinning quite so fast in his Memorial Vault ( these things have grand names).  That is assuming ashes can spin! We seem to be taking a familiar path where out of touch central bankers claim to be boosting business but we find that the cheap liquidity is indeed poured into the banks. But it seems to get lost as the promises of more business lending now morph into us seeing more and cheaper mortgage lending later. That boosts the banks and house prices in what so far has appeared to be a never ending cycle. Meanwhile the Funding for Lending Scheme started in the summer of 2012 so I think we should have seen the boost to lending to smaller businesses by now don’t you?

Meanwhile I see everywhere that not only is QE looking permanent my theme of “To Infinity! And Beyond” has been very prescient. No doubt we get more stories of “Top Men” ( or women) recommending ever more. Indeed it is not clear to me that a record in HM Treasury and the position below qualifies.

he joined the International Monetary Fund in 2008 where he headed the Fiscal Affairs Department’s Public Finance Division and worked on fiscal reform in a range of crisis-hit advanced, emerging, and developing countries.

 

 

The Chinese way of economic stimulus has started already in 2020

Firstly welcome to the new year and for some the new decade ( as you could argue it starts in 2021). The break has in some ways felt long and in other ways short but we have begun a new year with something familiar. After the 733 interest-rate cuts of the credit crunch era the People’s Bank of China ( PBOC ) has started 2020 with this.

In order to support the development of the real economy and reduce the actual cost of social financing, the People’s Bank of China decided to reduce the deposit reserve ratio of financial institutions by 0.5 percentage points on January 6, 2020 (excluding finance companies, financial leasing companies, and auto finance companies).

This is a different type of monetary easing as it operates on the quantity of money ( broad money) rather than the price or interest-rate of it. By increasing the supply ( with lower reserves banks can lend more) there may be cheaper loans but that is implicit rather than explicit. As to the size of the impact Reuters has crunched the numbers.

China’s central bank said on Wednesday it was cutting the amount of cash that all banks must hold as reserves, releasing around 800 billion yuan ($114.91 billion) in funds to shore up the slowing economy.

Care is needed here as we see some copy and pasting of the official release. This is because that is the maximum not the definite impact and also because the timing is uncertain. No doubt some lending will happen now but we do not know when the Chinese banks will use up the full amount. That is one of the reason’s we in the West stopped using this as a policy option ( the UK switched in the 1970s) as it is unreliable in its timing or more specifically more unreliable than interest-rate changes, or so we thought.

Speaking of timing there is of course this.

Freeing up more liquidity now would also reduce the risks of a credit crunch ahead of the long Lunar New Year holidays later this month, when demand for cash surges. Record debt defaults and problems at some smaller banks have already added to strains on China’s financial system.

The PBOC said it expects total liquidity in the banking system to remain stable ahead of the Lunar New Year. ( Reuters).

Although for context this is the latest in what has become a long-running campaign.

The PBOC has now cut RRR eight times since early 2018 to free up more funds for banks to lend as economic growth slows to the weakest pace in nearly 30 years.

You could argue the number of RRR cuts argues against its usefulness as a policy but these days interest-rate changes have faced the same issue.

The translation of the official view is below.

The People’s Bank of China will continue to implement a prudent monetary policy, remain flexible and appropriate, not flood flooding, take into account internal and external balance, maintain reasonable and adequate liquidity, and increase the scale of currency credit and social financing in line with economic development and stimulate the vitality of market players. High-quality development and supply-side structural reforms create a suitable monetary and financial environment.

I would draw your attention to “flood flooding” but let’s face it that makes a similar amount of sense to what other central banks say and write!

I note that it is supposed to help smaller companies but central banks have plugged that line for some time now. The Bank of Japan gave it a go and in my country the Bank of England introduced the Funding for Lending Scheme to increase bank lending to smaller and medium-sized businesses in 2012. The reality was that mortgage lending and consumer credit picked up instead.

Of the latest funds released, small and medium banks would receive roughly 120 billion yuan, the central bank said, stressing that it should be used to fund small, local businesses.

The banks

Having said that this was different to policy in the West there is something which is awfully familiar.

The PBOC said lower reserve requirements will reduce banks’ annual funding costs by 15 billion yuan, which could reduce pressure on their profit margins from recent interest rate reforms. Last week, it said existing floating-rate loans will be switched to the new benchmark rate starting from Jan. 1 as part of a broader effort to lower financing costs. ( Reuters ).

I guess central banks are Simon and Garfunkel fans.

And I’m one step ahead of the shoe shine
Two steps away from the county line
Just trying to keep my customers satisfied,
Satisfied.

The Chinese Economy

There is something of an economic conundrum though if we note the latest economic news.

BEIJING, Dec. 31 (Xinhua) — The purchasing managers’ index (PMI) for China’s manufacturing sector stood at 50.2 in December, unchanged from November, the National Bureau of Statistics (NBS) said Tuesday.

A reading above 50 indicates expansion, while a reading below reflects contraction.

This marks the second straight month of expansion, partly buoyed by booming supply and demand as well as increasing export orders, said NBS senior statistician Zhao Qinghe.

“booming supply and demand”. Really? Well there is growth but hardly a boom/

On a month-on-month basis, the sub-index for production gained 0.6 points to 53.2 in December,

Even it is not backed up by demand.

while that for new orders fell slightly to 51.2, still in the expansion zone.

The wider economy is recorded as doing relatively well.

Tuesday’s data also showed China’s composite PMI slid slightly to 53.4, but was 0.3 points higher than this year’s average, indicating steady expansion in the production of China’s companies.

Stock Market

According to Yuan Talks it as ever liked the idea although it is only one day.

#Shanghai Composite index extends gains to 1.5% to approach 3100 mark. #Shenzhen Component Index and #Chinext index are surging near 2%.

Still President Trump would be a fan.

Yuan or Renminbi

Here we see that we have been on a bit of a road to nowhere over the past year. After weakening in late summer towards 7.2 versus the US Dollar the Yuan at 6.96 is up 1.2% on a year ago. So there have been a lot of column inches on the subject but in fact very little of them have been sustained.

Comment

It would appear that the PBOC does not have much faith in the reports of a pick up in the Chinese economy as it has already stepped up its easing programme. There are other issues in play such as the trade war and these next two so let us start with US Dollar demand.

China’s big bang opening of its $45 trillion financial industry begins in earnest next year — a step-by-step affair that’s unfolding just as economic strains threaten the promised windfall luring in global firms.

Starting with its insurance and futures markets, the Communist Party ruled nation will enact the most sweeping changes in decades to allow the likes of Goldman Sachs Group Inc., JPMorgan Chase & Co. and BlackRock Inc. to expand their footprint in China and compete for a slice of its growing wealth. ( Insurancejournal.com )

Will it need a dollar,dollar? We will have to see. Also this issue continues to build.

WARSAW (Reuters) – Bird flu has been detected in turkeys in eastern Poland, authorities said on Wednesday, and local media reported that the outbreak could require up to 40,000 birds to be slaughtered.

China has a big issue with this sort of thing and like in banking and economics the real danger was always possible contagion. So far it has had limited effect on UK pork prices for example as the annual rate of inflation is 0.7% but it is I think a case of watch this space.

Meanwhile according to Yuan Talks the credit may not flow everywhere.

Regulators in the city of Beijing warned financial institutions about risks in the lending to property developers with “extremely high leverage”, indicating the authority is not relaxing financing rules for the cash-starved sector as many anticipated.

Looking at it in terms of money supply growth an annual rate of 8.2% for broad money ( M2) may seem fast in the west but it has not changed much recently in spite of the easing and is slow for China.

 

 

Will UK real wages and its banks ever escape the depression they seem trapped in?

Today brings the UK labour market into focus and in particular the situation regarding both real and nominal wage growth. Before we get to that there was news yesterday evening from the Bank of England on one of the highest paid categories.

The 2019 stress test shows the UK banking system is resilient to deep simultaneous recessions in the UK and global economies that are more severe overall than the global financial crisis, combined with large falls in asset prices and a separate stress of misconduct costs. It would therefore be able to withstand the stress and continue to meet credit demand from UK households and businesses.

Yes it is time for the results of the annual banking stress tests which of course are designed to look rigorous but for no-one to fail. So far the Bank of England has avoided the embarrassment of its Euro area peers who have seen a collapse quite soon after. In terms of the detail there is this.

Losses on corporate exposures are higher than in previous tests, reflecting some deterioration in asset quality and a more severe global scenario. Despite this, and weakness in banks’ underlying profitability (which reduces their ability to offset losses with earnings), all seven participating banks and building societies remain above their hurdle rates. The major UK banks’ aggregate CET1 capital ratio after the 2019 stress scenario would still be more than twice its level before the crisis.

As you can see the Bank of England is happy to slap itself on the back here as it notes capital ratios. Although of course higher capital ratios have posed their own problems abroad as we have seen in the US Repo crisis.

Major UK banks’ capital ratios have remained stable since year end 2018, the starting point of the 2019 stress test. At the end of 2019 Q3, their CET1 ratios were over three times higher than at the start of the global financial crisis. Major UK banks also continue to hold sizeable liquid asset buffers.

Actually the latter bit is also an explanation as to why banks struggle to make profits these days and why many think that their business model is broken.

Also I note that their view is that the highest rate of annual house price growth in the period 1987-2006 was 6.6% and the average 1.7%. I can see how they kept the average low by starting at a time that then saw the 1990-92 drop but only 6.6% as a maximum? Odd therefore if prices have risen so little that house prices to income seem now to have become house prices versus household disposable income and thereby often two incomes rather than one.

In terms of share prices this does not seem to have gone down that well with Lloyds more than 4% lower at 64 pence, Royal Bank of Scotland more than 3% lower at 252.5 pence and Barclays over 3% lower at 186 pence. Meanwhile it is hard not to have a wry smile at the fact that the UK bank which you might think needs a stress test which is Metro Bank was not included in the test. Although it has not avoided a share price fall today as it has fallen over 3% to 198 pence. Indeed, this confirms that it is the one which most needs a test as we note it was £22 as recently as January.

Labour Market

Let us start with what are a couple of pieces of good news.

The UK employment rate was estimated at 76.2%, 0.4 percentage points higher than a year earlier but little changed on the previous quarter; despite just reaching a new record high, the employment rate has been broadly flat over the last few quarters.

They get themselves into a little bit of a mess there so let me zero in on the good bit which is tucked away elsewhere.

There was a 24,000 increase in employment on the quarter.

There was also a favourable shift towards full-time work.

This was driven by a quarterly increase for men (up 54,000) and full-time employees (up 50,000 to a record high of 20.71 million), but partly offset by a 30,000 decrease for women and a 61,000 decrease for part-time employees.

I do not know why there was some sexism at play and suspect it is just part of the ebb and flow unless one of you have a better suggestion.

The next good bit was this.

the estimated UK unemployment rate for all people was 3.8%, 0.3 percentage points lower than a year earlier but largely unchanged on the previous quarter…….For August to October 2019, an estimated 1.28 million people were unemployed. This is 93,000 fewer than a year earlier and 673,000 fewer than five years earlier.

There were fears that the unemployment rate might rise. But the reality has been reported by the BBC like this.

UK unemployment fell to its lowest level since January 1975 in the three months to October this year. The number of people out of work fell  by 13,000 to 1.281 million.

Wages

This area more problematic and complex so let me start my explanation with the data.

Estimated annual growth in average weekly earnings for employees in Great Britain slowed to 3.2% for total pay (including bonuses) and 3.5% for regular pay (excluding bonuses).

The first impact is simply of lower numbers than we have become used to especially for total pay. Let us move to the explanation provided.

The annual growth in total pay was weakened by unusually high bonus payments paid in October 2018 compared with more typical average bonus payments paid in October 2019.

I have looked at the detail and this seems to have been in the finance and construction sectors where bonus pay was £12 per week and £6 per week lower than a year before. I have to confess I am struggling to think why October 2018 was so good as the numbers now are in line with the others? Anyway this should wash out so to speak in the next 2 months as October 2018 really stood out. Otherwise I would be rather troubled about a monthly increase this year that is only 2.4% above a year before.

So if we now switch to regular pay then 3.5% is a bit lower than we had become used to but in some ways is more troubling. This is because the spot figure for October was 3.2% and it looks as if it might be sustained.

This public sector pay growth pattern is affected by the timing of NHS pay rises which saw some April 2018 pay increases not being paid until summer 2018. As a result, public sector pay estimates for the months April to July 2019 include two NHS pay rises for 2018 and 2019 when compared with 2018. In addition, the single month of April 2019 included a one-off payment to some NHS staff.

Thus public-sector pay growth has faded away and is also now 3.2% on a spot monthly basis.

Anyway the peaks and troughs are as follows.

construction saw the highest estimated growth at 5.0% for total pay and 5.4% for regular pay…….retail, wholesale, hotels and restaurants saw the lowest growth, estimated at 2.3% for total pay and 2.5% for regular pay; this is the sector with the lowest average weekly pay (£339 regular pay compared with £510 across the whole economy)

Comment

There are elements here with which we have become familiar. The quantity numbers remain good with employment rising and unemployment falling although the rate of change of both has fallen. Where we have an issue is in the area of wage growth. The context here is that it did improve just not as much as we previously thought it did. However we still have this.

In real terms (after adjusting for inflation), annual growth in total pay is estimated to be 1.5%, and annual growth in regular pay is estimated to be 1.8%.

That is calculated using the woeful CPIH inflation measure but by chance it at CPI are pretty similar right now, so I will simply point out it would be lower but still positive using RPI.

Thus we see that wage growth and inflation seem both set to fall over the next few months as we wait to see how that balances out. But the underlying issue is that we have an area which in spite of the recent improvements is still stuck in a depression.

For October 2019, average regular pay, before tax and other deductions, for employees in Great Britain was estimated at £510 per week in nominal terms. The figure in real terms (constant 2015 prices) is £472 per week, which is still £1 (0.2%) lower than the pre-recession peak of £473 per week for April 2008.

The equivalent figures for total pay in real terms are £502 per week in October 2019 and £525 in February 2008, a 4.3% difference.

Fingers crossed that we can escape it…..

 

Why is the US Repo crisis ongoing?

The US Repo crisis is something that seems to turn up every day, or if you prefer as often as we are told there is a solution to trade war between the US and China. On Friday the New York Federal Reserve or Fed provided another US $72.8 billion of overnight liquidity in return for Treasury Bonds ( US $56.1 billion) and Mortgage-Backed Securities ( US $16.7 billion). So something is still going on in spite of the fact that we have two monthly plus Repos ( 42 days) for US $25 billion each in play and 3 fortnightly ones totalling around US $59 billion. So quite a bit of liquidity continues to be deployed and this is before we get to the Treasury Bill purchases.

In accordance with this directive, the Desk plans to purchase Treasury bills at an initial pace of approximately $60 billion per month, starting with the period from mid-October to mid-November.

As an example Friday saw some US $7.525 billion of these bought. So the sums are getting larger.

How did this start?

The Bank for International Settlements or BIS which is the central bankers central bank puts it like this.

On 17 September, the secured overnight funding rate (SOFR) – the new, repo market-based, US dollar overnight reference rate – more than doubled, and the intraday range jumped to about 700 basis points. Intraday volatility in the federal funds rate was also unusually high. The reasons for this dislocation have been extensively debated; explanations include a due date for US corporate taxes and a large settlement of US Treasury securities. Yet none of these temporary factors can fully explain the exceptional jump in repo rates.

Indeed, as for a start the issue has proved to be anything but temporary.

Where the BIS view gets more interesting is via the role of the banks or rather a small group of them.

US repo markets currently rely heavily on four banks as marginal lenders. As the composition of their liquid assets became more skewed towards US Treasuries, their ability to supply funding at short notice in repo markets was diminished.

As the supply of reserves fell in the QT or Quantitative Tightening era they stepped up to the plate on a grand scale.

As repo rates started to increase above the IOER from mid-2018 owing to the large issuance of Treasuries, a remarkable shift took place: the US banking system as a whole, hitherto a net provider of collateral, became a net provider of funds to repo markets. The four largest US banks specifically turned into key players: their net lending position (reverse repo assets minus repo liabilities) increased quickly, reaching about $300 billion at end-June 2019 . At the same time, the next largest 25 banks reduced their demand for repo funding, turning the net repo position of the banking sector positive (centre panel, dashed line).

So things became more vulnerable as we note this.

At the same time, the four largest banks held only about 25% of reserves (ie funding that they could supply at short notice in repo markets).

Then demand for Repo funding was affected by the US Treasury.

After the debt ceiling was suspended in early August 2019, the US Treasury quickly set out to rebuild its dwindling cash balances, draining more than $120 billion of reserves in the 30 days between 14 August and 17 September alone, and half of this amount in the last week of that period. By comparison, while the Federal Reserve runoff removed about five times this amount, it did so over almost two years

As you can see the drain from QT was added to in spite of the fact that the market had become more vulnerable due to the lack of players. There was a clear lack of joined up thinking at play and perhaps a lack of any thinking at all. A factor here was something the BIS identifies for the banks.

For instance, the internal processes and knowledge that banks need to ensure prompt and smooth market operations may start to decay. This could take the form of staff inexperience and fewer market-makers, slowing internal processes

After a decade the experienced hands had in general moved on.

But it was not enough to collapse the house of cards. There were other nudges as well on the horizon.

Market commentary suggests that, in preceding quarters, leveraged players (eg hedge funds) were increasing their demand for Treasury repos to fund arbitrage trades between cash bonds and derivatives. Since 2017, MMFs have been lending to a broader range of repo counterparties, including hedge funds, potentially obtaining higher returns.

So hedge funds were playing in the market but as it happened were not an issue for a while as the US Money Market Funds (MMF) turned up. But then they didn’t.

 During September, however, quantities dropped and rates rose, suggesting a reluctance, also on the part of MMFs, to lend into these markets. Market intelligence suggests MMFs were concerned by potential large redemptions given strong prior inflows. Counterparty exposure limits may have contributed to the drop in quantities, as these repos now account for almost 20% of the total provided by MMFs.

So there is a hint that maybe a hedge fund or two became such large players that they hit counterparty limits. Also redemptions from MMFs would hardly be a surprise as we note the interest-rate cuts we have seen in 2019.

Why should we care?

There is this.

 Repo markets redistribute liquidity between financial institutions: not only banks (as is the case with the federal funds market), but also insurance companies, asset managers, money market funds and other institutional investors. In so doing, they help other financial markets to function smoothly.

So they oil the wheels of financial markets and when they don’t? Well that is one of the causes of the credit crunch.

The freezing-up of repo markets in late 2008 was one of the most damaging aspects of the Great Financial Crisis (GFC).

In case you did not know what they are.

A repo transaction is a short-term (usually overnight) collateralised loan, in which the borrower (of cash) sells a security (typically government bonds as collateral) to the lender, with a commitment to buy it back later at the same price plus interest.

Also it is one of those things which get little publicity ( mostly ironically because they usually work smoothly) but there is a lot of action.

 Thus, any sustained disruption in this market, with daily turnover in the US market of about $1 trillion, could quickly ripple through the financial system.

Comment

Some of the factors in the Repo crisis were unpredictable. But it is also true that the US Fed was at best rather flat-footed. There had been a long-running discussion over the use of Interest On Excess Reserves or IOER to banks on such a scale which was not resolved. Then there was the way that so few banks (4) were able to become such large players creating an obvious risk. Then the role of the MMFs as by their very nature they flow into and out of markets and are likely to flow out when interest-rates are declining.

The BIS analysis adds to what we know but changes in stocks give us broad trends rather than telling what flowed where or rather did not flow on September 17th or since. As David Bowie put it.

Ch-ch-ch-ch-changes
Turn and face the strange
Ch-ch-changes
Don’t want to be a richer man
Ch-ch-ch-ch-changes
Turn and face the strange
Ch-ch-changes
There’s gonna have to be a different man
Time may change me
But I can’t trace time

Number Crunching

The BIS has been looking into some other areas.

An analysis of the #TriennialSurvey finds that global notional for #OTCderivatives rose to $640 trn in 2019, dominated by #InterestRateDerivatives

Average daily turnover of OTC interest rate derivatives more than doubled over 2016-19 to $6.5 trillion, taking OTC markets’ share to almost half total trading

30 years, 53 countries, 1,300 reporting dealers, and $6.6 trillion daily FX trades,

Weekly Podcast

 

Italy faces yet more economic hard times

This morning has brought more signs of the economic malaise that is affecting Italy, a subject which just goes on and on and on. Here is the statistics office.

In 2019, GDP is expected to increase by 0.2 percent in real terms. The domestic demand will provide a contribution of 0.8 percentage points while foreign demand will account for a positive 0.2 percentage point and inventories will provide a negative contribution (-0.8 percentage points).

That is a reduction of 0.1% on the previous forecast. In one way I doubt their forecasts are accurate to 0.1% but then in another way counting 0.1% growth is their job in Italy. The breakdown is odd though. As the net foreign demand may be small but any growth is welcome at a time of a time war but with domestic demand growing why are inventories being chopped?

So annual economic growth has gone 1.7% in 2017 and 0.8% last year and will now be 0.2% if they are correct. They do manage a little optimism for next year.

In 2020, GDP is estimated to increase by 0.6 percent in real terms driven by the contribution of domestic demand (+0.7
percentage points) associated to a positive contribution of the foreign demand (+0.1 p.p.) and a negative contribution of inventories (-0.2 p.p.).

So the main change here is that the decline in inventories slows. If we switch to a positive we are reminded that Italy’s trade position looks pretty good for these times.

In 2019, exports will increase by 1.7 percent and imports will grow by 1.3 percent, both are expected
to slighty accelerate in 2020 (+1.8% and +1.7% respectively)

Looking at domestic demand it will be supported by wages growth and by this.

Labour market conditions will improve over the forecasting period but at moderate pace. Employment
growth is expected to stabilise at 0,7 percent in 2019 and in 2020. At the same time, the rate of
unemployment will decrease at 10.0 percent in the current year and at 9.9 percent in 2020.

They mean 10% this year and 9.9% next although there is a catch with that.

The number of unemployed persons declined (-1.7%, -44 thousand in the last month); the decrease was the result of a remarkable drop among men and a light increase for women, and involved all age groups, with the exception of over 50 aged people. The unemployment rate dropped to 9.7% (-0.2 percentage points), the youth rate decreased to 27.8% (-0.7 percentage points).

As you can see the unemployment rate was already below what it is supposed to be next year so I struggle to see how that is going to boost domestic demand. Perhaps they are hoping that employment will continue to rise.

In October 2019 the estimate of employed people increased (+0.2%, +46 thousand); the employment rate rose at 59.2% (+0.1 percentage points).

The Markit PMIs

There was very little cheer to be found in the latest private-sector business survey published earlier.

The Composite Output Index* posted at 49.6 in November,
down from 50.8 in October and signalling the first decline in Italian private sector output since May. Despite this, the rate of contraction was marginal.
Underpinning the latest downturn was a marked slowdown
in service sector activity growth during November, whilst
manufacturing output recorded its sixteenth consecutive
month of contraction. The latest decrease was sharp but
eased slightly from October.

I doubt anyone is surprised by the state of play in Italian manufacturing so the issue here is the apparent downturn in the service sector. This leads to fears about December and for the current quarter as a whole. Also the official trade optimism is not found here.

Meanwhile, export sales continue to fall.

Sadly there is little solace to be found if we look at the wider Euro area.

The final eurozone PMI for November came in
slightly ahead of the earlier flash estimate but still
indicates a near-stagnant economy. The survey
data are indicating GDP growth of just 0.1% in the
fourth quarter, with manufacturing continuing to act
as a major drag. Worryingly, the service sector is
also on course for its weakest quarterly expansion
for five years, hinting strongly that the slowdown
continues to spread.

Unicredit

We have looked regularly at the Italian banking sector and its tale of woe. But this is from what is often considered its strongest bank.

After cutting a fifth of its staff and shutting a quarter of its branches in mature markets in recent years, UniCredit said it would make a further 8,000 job cuts and close 500 branches under a new plan to 2023………UniCredit’s announcement triggered anger among unions in Italy, where 5,500 layoffs and up to 450 branch closures are expected given the relative size of the network compared with franchises in Germany, Austria and central and eastern Europe.

Back in January 2012 I described Unicredit as a zombie bank on the business programme on Sky News. It has spent much if not all of the intervening period proving me right. That is in spite of the fact that ECB QE has given it large profits on its holdings of Italian government bonds. Yet someone will apparently gain.

UniCredit promised 8 billion euros ($9 billion) in dividends and share buybacks on Tuesday in a bid to revive its sickly share price, although profit at Italy’s top bank will barely grow despite plans to shed 9% of its staff.

This is quite a mess as there are all sorts of issues with the share buyback era in my opinion.  In the unlikely event of me coming to power I might rule them ultra vires as I think the ordinary shareholder is being manipulated. Beneath this is a deeper point about lack of reform in the Italian banking sector and hence its inability to support the economy. This is of course a chicken and egg situation where a weak economy faces off with a weak banking sector.

Mind you this morning Moodys have taken the opposite view.

The outlook for Italy’s banking system has changed to stable from negative as problem loans will continue to fall, while banks’ funding conditions improve and their capital holds steady, Moody’s Investors Service said in a report published today.

“We expect Italian banks’ problem loans to fall in 2020 for a fifth consecutive year,” said Fabio Iannò, VP-Senior Credit Officer at Moody’s. “However, their problem loan ratio of around 8% remains more than double the European Union average of 3%, according to European Banking Authority data. We also take into account our forecast for weak yet positive Italian GDP growth, and our stable outlook on Italy’s sovereign rating.”

What could go wrong?

Comment

There is a familiar drumbeat and indeed bass line to all of this. In the midst of it I find it really rather amazing that Moodys can take UK banks from stable to negative whilst doing the reverse for Italian ones! As we look for perspective we see that the “Euro boom” and monetary easing by the ECB saw annual economic growth of a mere 1.7% in 2017 which has faded to more or less zero now. We are back once again to the “girlfriend in a coma” theme.

Italy has strengths in that it has a solid trade position and is a net saver yet somehow this never seems to reach the GDP data. Maybe the grey economy provides an answer but year after year it fails to be measured. Of course if politico are correct there is always plenty of trade and turnover here.

Italy’s new coalition government might not last the winter, with tensions reaching a peak this week over EU bailout reform……The 5Stars oppose the planned ESM reform because they say it would make it harder for highly indebted countries, like Italy, to access bailout funds without painful public-debt restructuring.

That reminds me about fiscal policy which is the new go to in the Euro area according to ECB President Christine Lagarde, well except for Italy and Greece.

 

 

 

Negative interest-rates are on the march yet again

A feature of the modern era is that things which are permanent are described as “temporary”. This has been particularly true in the era of interest-rates as it is easy to forget now that the low interest-rates of 2009/10 were supposed to be so. The reality is that they went even lower and in more than a few places went negative which again was supposed to be temporary. But the list got longer along the lines of the famous Elvis Presley song.

We’re caught in a trap
I can’t walk out
Because I love you too much baby

I have written before that I think that there are two factors in this being passed onto the ordinary depositor. Firstly how negative interest-rates become and secondly how long they are negative for. The reason why there is any delay in the pass on to depositors and savers is that the banks are afraid they will withdraw their cash and hence break their business model apart.

Germany

On the 19th of last month we noted that some German banks were looking to spread the negativity net wider and according to Bloomberg some smaller ones have broken ranks.

After five years of negative rates imposed by the European Central Bank, German lenders are breaking the last taboo: Charging retail clients for their savings starting with very first euro in the their accounts.

While many banks have been passing on negative rates to retail clients for some time, they have typically only done so for deposits of 100,000 euros ($111,000) or more. That is changing, with one small lender close to Munich planning to impose a rate of minus 0.5% to all savings in certain new accounts. Another bank in the east of the country has introduced a similar policy and a third is considering an even higher charge.

This is the system we have some to expect where a small bank or two is used as a pathfinder to test the water. I wonder if there is some sort of arrangement here although this from Bloomberg is also true.

 While there are some exemptions under the policy, years of sub-par profitability have left especially smaller lenders with few options to offset the cost of the ECB’s charges.

The irony is not lost on me that policies brought in to protect “The Precious” are now damaging it and may yet destroy it. I also find it fascinating to whom Bloomberg went for an opinion as it is straight out of the European equivalent of Yes Prime Minister.

“For now, negative rates are probably a signal to new clients that a bank doesn’t need any additional deposits,” said Isabel Schnabel, a professor at the University of Bonn who was nominated by Germany to join the ECB’s Executive Board. “I would assume that banks are a lot more cautious with existing customers.”

Kylie Minogues “Spinning Around” should be playing in the background to that. Still Isabel should fit in well with the ECB Executive Board as we get some strong hints as to why she was nominated.

Who is it?

The banks are shown below.

Now Volksbank Raiffeisenbank Fuerstenfeldbruck, a regional bank close to Munich, is among the first brushing off such concerns. The bank says it will impose a negative rate of 0.5% on new clients who open a popular form of saving account……….Kreissparkasse Stendal, in the east of the country, has a similar policy for clients who have no other relationship with the bank. Both lenders levy the charges on new customers who open a type of savings account that allows for daily, unlimited withdrawals, a popular instrument among German savers. Existing customers are mostly exempt for now.

The way that this has been such a slow process shows that the banks are afraid of deposit flight or a type of run on the bank. So far we do not know when that would occur although we do know now that some versions of negative interest-rates do not cause it. As the plan below is for an extra -0.05% it seems unlikely to be the trigger.

Frankfurter Volksbank, one of the country’s largest cooperative lenders, is considering going even further and charging some new customers 0.55% for all their deposits, Frankfurter Allgemeine Zeitung reported, without saying where it got the information. The lender said in a statement it has not made any decisions yet.

Denmark

The Straits Times has picked up on an interview by the Governor of the central bank Lars Rhode and it is rather revealing.

In Denmark, where banks have lived with negative rates since 2012, it’s now clear that life below zero isn’t about to end any time soon. People need to understand that it’s “lower for longer”, Rohde said. And that will “definitely” have negative consequences for lenders, he said.

He also gave a speech yesterday and in it there was this.

Digitalisation and new legislation give more players access to the market for bank products. From the payments market we know that digital solutions have a tendency to create natural monopolies because it costs less to perform one extra transaction once the digital infrastructure is in
place.

That was ominous as banks already have problems with their business model and it got worse as he told them who he had in mind.

In recent years, we have seen tech giants, such as Apple and Amazon, enter the financial market. Experience from both the USA and China shows that these firms are extending their original core business to include payments and subsequently also financial services such as
lending.

Is he telling them they are obsolete and dinosaurs. Still he did manage some humour.

Well-functioning IT systems and a tight rein on costs will be key competitive parameters for banks in the coming years.

As the Straits Times puts it.

But years of negative rates, tougher regulatory requirements and, in some cases, out of date technology, have put some banks on the back foot.

Indeed this may put a chill down bankers spines.

According to a report in Borsen on Tuesday, Apple Pay has now established itself as a considerably more popular app among Danish shop owners than a local mobile payment solution offered by Nets A/S, which has so far dominated digital payments within the Nordic region.

So far Danish banks are resisting the trend towards negative interest-rates for all.

For now, lenders have drawn the line at 750,000 kroner (S$152,000), which is the threshold below which deposits are covered by guarantees.

Comment

There is a steady drip drip here and there is some other news which suggests to me that the ECB may be genuinely afraid. In its latest round of monetary easing there was also tiering of deposits for banks at the ECB itself which may reduce the costs there by a third. But in the last week or two there are signs of something more subtle regarding bank capital.

Enter Mr Enria new head of the SSM… And Unicredit’ s new business plan presented this morning. In which they make clear that Pillar 2 would be CET1 AT1 and T2. This means in practice :

A) a big CET1 relief for banks (80bps for Unicredit)

B) a massive need of new AT1/T2

( @jeuasommenulle )

He thinks that today’s announcement from Unicredit of Italy hints that the capital requirements for risk-weighted assets are being trimmed. There has been a change in who is in charge and more flexibility seems to be in the offing. This adds to the hint provided last week in the proposed banking merger between Unicaja and Liberbank as in the past it might have been stymied by a demand for more capital. Oh and SSM is Single Supervisory Mechanism.

This echoes partly because of this if we return to the Governor of the Danish central bank.

This creates an underlying need for consolidation, also within the financial sector.

So it is a complex picture and remember some policymakers at the ECB wanted to turn the screw even harder with a Deposit Rate of -0.6%.

 

 

The ECB starts to face up to some of the problems of the Euro area banks

Today has brought the Euro area financial sector and banks in particular into focus as the ECB ( European Central Bank ) issues its latest financial stability report. More than a decade after the credit crunch hit one might reasonably think that this should be a story of success but it is not like that. Because the ECB is rather unlikely to put it like this a major problem is that the medicine to fix the banks ( lower interest-rates) turned out to be harmful to them if you not only continued but increased the dose. Or as Britney Spears would put it, the impact of negative interest-rates on banks is.

I’m addicted to you
Don’t you know that you’re toxic?
And I love what you do
Don’t you know that you’re toxic?

Actually the FSR starts with another confession of trouble as it reviews the Euro area economy.

The euro area economic outlook has deteriorated, with growth expected to remain subdued for longer. Mirroring global growth patterns, information since the previous FSR indicates a more protracted weakness of the euro area economy, leading to a downward revision of real GDP growth forecasts for 2020-21.

There is the by traditional element of blaming Johnny Foreigner which has some credibility with the trade war issue. However if we look deeper we were reminded only yesterday about the told of the Euro area in its genesis.

In September 2019 the current account of the euro area recorded a surplus of €28 billion, compared with a surplus of €29 billion in August 2019. In the 12-month period to September 2019, the current account recorded a surplus of €321 billion (2.7% of euro area GDP), compared with a surplus of €378 billion (3.3% of euro area GDP) in the 12 months to September 2018.

It sometimes gets forgotten now that one of the factors in the build-up to the credit crunch was the Euro area ( essentially German ) trade surplus.

However the essential message here is that lower economic growth is providing a challenge to the Euro area financial sector and banks and tucked away at the bottom of this section is one of the reasons why.

At the same time, inflationary pressures in the euro area are forecast to remain muted over the next two years, translating into overall weaker nominal growth prospects.

Paying down debt can be achieved via inflation as well as real economic growth and is one of the reasons why the ECB keeps implementing policies to get inflation up towards its 2% per annum target. A sort of stealth tax.

Bond Markets

There is a warning here.

Asset valuations, reliant on low interest rates, could face future corrections.

If we start with sovereign bonds then there is am implied danger for Germany as it has the largest sector with negative yields. But if we switch to banking exposure then eyes turn to Italy because not only does it have a large relative national debt but its banks hold a relatively large proportion of it at 20%. They will have done rather well out of the ten-year yield falling by over 2% to 1.3% over the past year but is that the only way Italian banks make money these days? There is a reflection of this sort of thing below.

Very low interest rates, coupled with the large number of investors which have gradually increased the duration of their fixed income portfolios, could exacerbate potential losses if an abrupt repricing were to materialise in the medium-to-long run.

Tucked away is an arrow fired at Germany.

there is a strong case for governments with fiscal space to act in an effective and timely manner.

What about the banks?

Here we go.

Bank profitability concerns remain prominent. Bank profitability prospects have weakened against the backdrop of the deteriorating growth outlook  and the low interest rate environment, especially for banks also facing structural cost and income challenges (see Special Feature A).

Nobody seems to want to back them with their money.

Reflecting these concerns, euro area banks’ market valuations remain depressed with an average price-to-book ratio of around 0.6.

Although the ECB would not put it like this if this was a rock concert the headliner would be my old employer Deutsche Bank. It has a share price of 6.5 Euros which certainly must depress long-term shareholders who have consistently lost money. There have been rallies in this example of a bear market and well played if you have taken advantage but each time they have been followed by Alicia Keys on the stereo.

Oh, baby
I, I, I, I’m fallin’
I, I, I, I’m fallin’
Fall
I keep

This bit is both true and simply breathtaking!

Banks have made slow progress in addressing structural challenges to profitability.

If you have policies which are fertiliser for zombie banks then complaining about a march of the zombies is a bit much. In this area it is Halloween every day.

If you are wondering about Special Feature A so was I.

These banks all stand out in terms of elevated cost-to-income ratios. But there also appear to be three distinct groups: (i) banks struggling with legacy asset problems; (ii) banks with weak income-generation capacity; and (iii) banks suffering from a combination of cost and revenue-side problems.

We are told this is only for a “sub set” but point (iii) is plainly a generic issue in the Euro area banking sector. The proposed solution looks not a little desperate.

But in systems with many weak-performing small banks, consolidation within their domestic system could improve performance. Finally, a combination of bank-level restructuring and cross-border M&A activity could help reduce the costs and diversify the revenues of large banks that are performing poorly.

Consolidating the cajas in Spain and some of the smaller banks in Italy did reduce the number of banks in trouble but did not change the problem.There is a bit of shuffling deckchairs on the Titanic about this which turns to laughter as I consider “cross-border M&A activity”. Like RBS in the UK? That was one of the ways we got into this mess. One of the problems with banking right now is what do they diversify into?

On aggregate, euro area banks’ return on equity is expected to remain low, limiting the sector’s ability to increase resilience through retained earnings

Er well yes.

Should this all go wrong we will be told we were warned.

A banking system operating with significant overcapacity is also vulnerable to weak competitors driving down lending standards and an underpricing of risk.

Shadow Banking?

Some of the role of banks has moved elsewhere and of course there are plenty of issues for long-term savings in a negative interest-rate world.

After a slight decline in the last quarter of 2018, the total assets of investment funds (IFs), money market funds (MMFs), financial vehicle corporations, insurance corporations (ICs), pension funds (PFs) and other financial institutions gradually increased to almost €46 trillion in June 2019, and represented 56% of total financial sector assets.

Also what do you expect if you drive some corporate bond yields negative by buying so many of them?

But more recently, the low cost of market-based debt has supported a further increase in NFCs’ debt issuance – particularly of investment-grade bonds.

Can anybody remember a time when relying on bond ratings went wrong?

Negative interest-rates again.

As yields have fallen, non-bank financial intermediaries hold a growing share of low-yielding bonds, which decreases their investment income in the medium term and encourages risk-taking.

Comment

The press release is if we read between the lines quite damning.

Low interest rates support economic activity, but there can be side effects

Signs of excessive risk-taking in some sectors require monitoring and targeted macroprudential action in some countries

Banks have further increased resilience, but have made limited progress in improving profitability.

It is welcome that we are seeing some confession of central banking sins but it comes with something else I have noticed recently which is that ECB related accounts are taking the battle to social media.

Dear fellow German economists, if you are wondering what you can do for Europe: Please help to dispel the harmful & wrong narratives about the @ecb  ‘s monetary policy, floating around in political and media circles. These threaten the euro more than many other things.

That is from Isabel Schnabel who is the German government and Eurogroup approved candidate to be a new member on the ECB board. From the replies it is not going down too well but we can see clearly why she was appointed at least.

Me on The Investing Channel