Eurozone banking system on edge of collapse over collateral crunch

A Telegraph article reports that the Eurozone banking system is on the edge of collapse as the banks do not have access to funding due to a lack of assets that can be pledged as collateral.

Regular readers know that if Eurozone regulators required the Eurozone banks to provide ultra transparency this would not be a problem.

By disclosing on an on-going basis their current assets, liabilities and off-balance sheet exposure details, market participants can value every exposure.

With market values on all of the assets that a bank has, particularly the loan portfolio, the bank expands the collateral it can pledge to the ECB.  Today, the bank can only pledge loans that have been put into a covered bond or securitization structure.  With ultra transparency, banks will be able to pledge any loan on their balance sheet.

Using the loan portfolio to secure funding from the ECB frees up the other assets, like securities, to be used to fund through the repurchase market.

The other advantage of offering ultra transparency is that market participants can evaluate the riskiness of each bank.  When lenders can see that they are going to be repaid, it makes it easier to access money through the repo and inter-bank funding markets.

Senior analysts and traders warned of impending bank failures as a summit intended to solve the European crisis failed to deliver a solution that eased concerns over bank funding. 

The European Central Bank admitted it had held meetings about providing emergency funding to the region's struggling banks, however City figures said a "collateral crunch" was looming. 

"If anyone thinks things are getting better then they simply don't understand how severe the problems are. I think a major bank could fail within weeks," said one London-based executive at a major global bank. 

Many banks, including some French, Italian and Spanish lenders, have already run out of many of the acceptable forms of collateral such as US Treasuries and other liquid securities used to finance short-term loans and have been forced to resort to lending out their gold reserves to maintain access to dollar funding. 

"The system is creaking. There is a large amount of stress," said Anthony Peters, a strategist at Swissinvest, pointing to soaring interbank lending rates. 

CreditSights' weekly funding report said the ECB had effectively become the central clearer for the region's banks as lenders are increasingly distrustful about funding one another. 

Bank deposits with the ECB now stand at their highest level since June 2010 at €905bn (£772bn) as lenders withdraw deposits held with their peers and put them into the central bank. 

At the same time, banks in major eurozone countries such as France and Italy have become increasingly reliant on central bank funding. This follows the trend seen in smaller countries like Ireland where lenders have effectively becomes taxpayer-funded "zombie" banks. 

Alastair Ryan, a banks analyst at UBS, said there would be "no Lehman moment" – or single catastrophic event – for the European banking sytem, but added that without a full backstop of bank liabilities by governments the system would "struggle to finance itself in the next year in a durable way". 

"The system at the moment hasn't got funding of a duration that allows it to function, so it's failing," he said. 

Others think the eurozone banks are heading for a catastrophe and the worry is growing that a major bank could collapse within weeks.... 

Moody's on Friday downgraded France's three largest banks, BNP Paribas, Credit Agricole and Societe Generale in light of what the US rating agency said were "liquidity and funding constraints". The banks' downgrade came despite Moody's acknowledging the three lenders could depend on a higher level of French taxpayer support in future.... 

The fear is the European authorities do not have the financial firepower to deal with the banks' problems. 

Analysts at BarCap say that even if the European rescue funds were able to raise €1 trillion of funding this would only meet the needs of the Italian and Spanish government and banks.

The European banking sector's problems are being exacerbated by a wave of asset sales as lenders look to dramatically shrink their balance sheets. UBS estimates eurozone banks could sell off between €3.7 trillion and €4.5 trillion of assets in the next three years.

These asset sales of course are the result of a regulatory policy that requires Eurozone banks to achieve the meaningless 9% Tier I capital ratio.  Selling their good assets and keeping their troubled assets so as to show a higher capital ratio does not improve the outlook for Eurozone bank solvency.