Monday, November 28, 2011

European Banking Authority warns on bank funding...ultra transparency emerges as only solution

A Reuter's article reports on how the European Banking Authority (EBA) is growing increasingly concerned over the fact that the inter-bank funding market is frozen and Eurozone banks need to rollover almost $1 trillion in debt.

The EBA is looking at all the solutions tried in 2008-09 to unfreeze the market -- for example, state guarantees, stress tests, higher capital ratios -- and has concluded that these are not working.

The solutions are not working because banks simply do not trust each other or the sovereigns that stand behind them (this is not confined to the Eurozone as a collapse of the Eurozone banks will wreak havoc in the UK and US too).

Why don't banks trust each other?

Because banks are unable to evaluate the solvency of other banks.  As the Bank of England's Andy Haldane would say because each bank is a 'black box'.

Four years ago, I said predicted a solvency crisis driven by opacity in the financial marketplace.  One area of opacity is bank balance sheets.

Regular readers know that in order to assess the risk of a bank, market participants, including the bank's competitors, need access to the bank's current asset, liability and off-balance sheet exposure details on an on-going basis.

It is the ability to independently analyze this data that restores and maintains trust in the banks.

Until this data is made available, as I predicted, the financial system and the real economy will continue on a downward spiral.
Europe's finance chiefs try again next week to end a deadlock over bank funding, after the industry regulator warned time is running out to revive confidence across the troubled euro zone. 
Over breakfast on Wednesday, European Union finance ministers will seek agreement over state-backed guarantees in a bid to unblock wholesale funding markets. With 700 billion euros ($933 billion) of bank debt needing to roll over next year, the need is pressing. 
One solution touted, a pooling of state-backed guarantees, has effectively been abandoned, while another, individual national guarantees, is seen as unlikely to help banks in euro zone countries whose government bonds are being given a wide berth. 
The European Central Bank (ECB) may end up having to step in with a band-aid solution of two-to-three year liquidity lines to banks. 
The European Banking Authority (EBA) has drafted a three-pronged package to shore up confidence in banks: a 106 billion euro recapitalisation by mid-2012, writedowns on exposures to stressed sovereign debt and the funding guarantees. 
But EBA Chairman Andrea Enria signalled this week his increasing frustration with the deadlocked political process, including how to leverage the EU's new bailout fund, the EFSF. 
"The fact that so far only the EBA's measures to strengthen bank capital have been publicly put forward is for us a source of real concern," Enria said in a speech. "We believe that further delays to having all the elements in place are severely affecting the effectiveness of the whole package."... 
But the EBA package is already in danger of being left behind by the deepening euro zone crisis, making it harder for banks to find enough quality collateral to back loans and which is often in the form of government bonds. 
"With the sovereign debt crisis moving to the bigger euro zone countries, there is no longer any confidence in collateral, and the only way to get banks lending to each other again is to restore trust and confidence in sovereign debt used for collateral," said Godfried de Vidts, director of European Affairs at brokerage ICAP. 
So far the EBA is sticking with its timetable to publish by the end of November how much capital each bank must raise, but it and bankers now worry more about funding than capital. 
"We are in a bad spot," Stefano Marsaglia, chairman of Barclays Capital's financial institutions group, said at a Thomson Reuters IFR Bank Capital conference on Thursday. "The problem for banks is very much a funding problem, it's not so much a capital problem." 
The EBA has told banks they need to raise about 106 billion euros to repair their balance sheets, but that amount could rise as the watchdog may take a tougher line on what qualifies as capital and losses on sovereign bonds.... 
Banks are expected to mostly meet shortfalls by selling assets and loans, retaining earnings and cutting dividends or pay, and the amount of capital needing to be raised could be less than 30 billion euros, analysts have estimated.  
Regulators and national governments ... have become increasingly concerned that aggressive "deleveraging" to lift capital ratios will squeeze credit and hurt economic growth. 
Of course they are worried, as it appears that their policies have triggered a mini-credit crisis in the Eurozone.

To try to alleviate this de-leveraging, regulators are proposing a new way for banks to raise capital.
Banks will be given details of how they can plug their capital with debt that converts into equity, or "contingent capital" instruments dubbed CoCos. 
Contingent capital will be accepted if it meets "strict and harmonised" criteria, the EBA has said. It plans to issue a common European "term sheet" to make that clear. 
That is desperately needed, as uncertainty about how regulators view key aspects such as the point where bonds have to convert into equity -- probably when core Tier 1 capital drops to about 7 percent -- have held back issuance. 
But with some investors steering clear of investing in bank shares and most types of debt, market confidence will need to improve first.
Who would invest in contingent capital that converts to equity if they cannot assess the risk of the underlying bank?

Without ultra transparency, there is no real market for contingent capital.

The only way to improve market confidence is by providing ultra transparency.
UK investor M&G said where it has exposure to financials it is "very conservative" and senior in the capital structure. "That is unlikely to change soon. It is difficult to quantify banks' exposure to the periphery but the sector needs better disclosure, more liquidity and less reliance on interbank funding," said M&G fund manager Stefan Isaacs.
Investors, including banks making loans to each other, are on a buyers' strike until ultra transparency is provided.

No comments: