Just before Christmas, Standard Chartered's highly respected economics unit led by Gerard Lyons published its forecasts for 2012. For those in the West it made for pretty miserable reading – recession in the eurozone economies (GDP -1.5pc), recession in the UK (GDP -1.3pc), low growth in the US (GDP +1.7pc) and European sovereigns facing further downgrades as the single currency crisis shows little sign of resolution.
Entitled Fragile West, Resilient East, the report said ...
"In the West, the fundamentals are poor, the policy cupboard is almost empty and confidence has been shot to pieces. In contrast, across the emerging world, the fundamentals are good, the policy cupboard is almost full and confidence is likely to prove resilient."...
Sitting in his office on the corner of Basinghall Street in the City, Peter Sands, the chief executive of Standard Chartered, could be forgiven a small smile. His bank is almost wholly focused on the emerging markets of Asia and Africa, with little exposure to the eurozone. But such is the fear of eurozone failure that it is concentrating all minds.
"Obviously we close 2011 with a huge amount of focus on the trials and tribulations of the eurozone and I actually think the big news of last month's summit [in Brussels] was that unfortunately, once again, the eurozone's political leadership didn't really produce something that was compelling or credible as a plan to deal with the problems and to re-energise growth
in the eurozone," he said.
"So we enter 2012 with a very difficult outlook for the eurozone [and] with an increasing possibility of countries actually leaving the eurozone. Nobody should underestimate what a big deal that would be, because it would be very difficult to manage the contagion risk, even if it was only Greece."Regular readers know that "contagion risk" is a direct result of the opacity of the 'black box' banks. Nobody knows where the losses are.
Requiring the banks to provide ultra transparency by disclosing on an on-going basis their current asset, liability and off-balance sheet exposure details eliminates contagion risk. It does this because every market participant can adjust their exposure based on the risk of each bank to what they can afford to lose.
"The disruption from [a country leaving] would really be significant. It will have ramifications all over the world – both directly, because the simple maths is that the eurozone is a very large part of the global economy and if it is going slower then economic trade will be slower around the world. But there is also the confidence perspective."
Rather than become more optimistic as European summit after European summit attempted to knit together a deal to solve the sovereign debt crisis during 2011, Sands has looked on with increasing pessimism. I ask him if his position has hardened on the issue of whether the eurozone could really break apart. "Yes," he answers simply.
"I think the probability of countries leaving the eurozone has increased," he continues. "We have had several successive plans announced to solve the problem of the eurozone which simply haven't convinced the market and ultimately the current structure, shape and scope of the eurozone only works if the market believes it's worth supporting.
"We are in a path-dependent problem, where the solutions available at any one time are not necessarily available at the next step and so I think the solutions base has narrowed because we have missed opportunities."Previously, your humble blogger had also noted how the number of available, untried solutions was declining. For example, regulators had tried the combination of stress tests and bailouts and this had failed as the European banking system is seen by the market as being on the verge of collapse.
My conclusion was that Eurozone policymakers would turn to the solution that FDR and his administration used successfully to break the back of the Great Depression: ultra transparency. FDR and his administration were able to provide ultra transparency by offering an implied 100% guarantee of bank deposits.
With eurozone break-up would come lower growth and, as The Telegraph reported last week, the possible use of emergency measures such as capital controls to protect nations' economies. The economic dislocation which has brought demonstrations to the streets across the eurozone would pale by comparison with what might be unleashed.
"I think there is a real risk because these economic problems bring real social consequences - cuts in social provisions, higher rates of unemployment, very high rates of youth unemployment. There is a real risk of all this translating into greater calls for protectionism, more populist policies. I think it is quite easy to tell a story of 2012 that is quite depressing."...This is the reason that banks need to perform their safety valve function and act as a circuit breaker between the excesses of the financial markets and the real economy. Banks do this by recognizing their losses even if it means they have large, negative book equity values.
"One thing I am concerned about is that there is a degree of inward-looking insularity to much of the debate about regulatory policy that is on one level understandable, given what we've been through, but is potentially very damaging to the vibrancy and the ability of the City to compete and London-based institutions to compete in international markets."
Despite the threat from fresh waves of banking regulation from the implementation of the Independent Commission on Banking (ICB) reforms and the Government's announcement that the UK-only banking levy will increase from Sunday, Sands has always made it clear that the preferred option for Standard Chartered is retaining its London HQ. But, as a bank with most of its business focused in Asia and Africa and with investors constantly asking the question, analysts say it would be foolish to rule out other options.
"Our deposits in Bangladesh attract the UK bank levy," Sands says. "Nobody else's deposits in Bangladesh attract the UK bank levy apart from HSBC and they are much smaller than us [there]. So, none of our major competitors [faces the bank levy]. The whole issue of FSA super-equivalence, the FSA front-running what has been agreed on the international agenda, [means] we operate at a degree of competitive disadvantage."
One of the ICB's proposals is to impose higher levels of loss-absorbing capital on UK banks before the globally agreed Financial Stability Board and Basel rules come into force. It is not a matter of whether you agree with higher levels of such capital (as a matter of fact, Sands does), it is why, as Sands puts it, the UK "isn't moving with the [global] regulatory agenda"?However, higher capital without ultra transparency is meaningless.
Just look at what is happening in the Eurozone as banks are reducing their leverage to meet the regulators 9% Tier I capital ratio target. No one thinks the banks are any safer. Instead, they see the banks as riskier as they are selling off their performing assets to reach the capital ratio.
All the changes should be seen in the context of the huge global forces pushing the next phase of development from West to East. As the Government and the Financial Services Authority plan their latest assault on UK banking, the critics argue, the East looks at how it will promote its financial sector to support growth. The UK and Europe, many argue, are too busy looking back at 2007 and 2008 to see what is coming over the horizon.
"If you are too focused on driving looking in the rear-view mirror, you can either miss the tree in front of you or you simply don't know where you are going," Sands says.
The tree this time has proved to be the eurozone ....
Some say Standard Chartered is a "flight-to-quality" institution and that it is well placed – and resourced – to take advantage as eurozone-exposed banks rapidly deliver.
"The rougher the markets get, the more we attract liquidity," Sands says. "We have just been upgraded by S&P at a time when most other banks are getting cut. And I think we are the only bank that has been upgraded by all three rating agencies since the beginning of the crisis. So we are in a very strong position."
If the eurozone does collapse, of course, then few will be able to tell where the chips will fall.Actually, as far as the financial system is concerned, we should be able to tell where the chips will fall if the eurozone does collapse. The only reason the market cannot tell is because banks and structured finance securities are allowed to remain opaque.