It is the failure to deal with the troubled exposures that undermines the real economy. Remember, during the period from 1995 - 2010, Japan pursued the model of letting banks hide their losses on and off their balance sheets and saw its economy contract.
The economy is undermined because hiding the losses artificially distorts the prices of real assets. For example, real estate prices remain much higher than would be the case if the losses were known.
Even as the European banking crisis shows signs of easing, lenders across the Continent are engaging in a variety of maneuvers to avoid, or at least delay, coming to terms with potential problems lurking on their books.
Some banks are concocting unorthodox structures designed to improve all-important capital ratios, without raising new capital or moving unwanted assets off their balance sheets.As discussed previously, it is the ease with which banks can manipulate book capital that renders it meaningless in the absence of ultra transparency.
Others are engaging in complex transactions with struggling customers to help temporarily avoid loan defaults—but possibly exposing the lenders to future problems.
Banks now have greater flexibility to pursue such tactics because of the roughly €1 trillion ($1.33 trillion) of cheap three-year loans that the European Central Bank recently handed out to at least 800 lenders. ...
But by granting the new lease on life, the ECB program also has enabled the industry to delay its cleanup process, according to some bankers, investors and other experts.
"The LTRO has allowed for an extension of the period before which bank reconstruction is embraced, and the damage for the euro area could be material," said Alastair Ryan, a banking analyst with UBS.Under the Japanese model adopted at the beginning of the solvency crisis, banks have been delaying the cleanup process.
As a practical matter, the banks only recognize losses to the extent that they have earnings that exceed banker bonuses plus dividends plus a modest increase in reported book capital.
The tactics are most prevalent in Spain, where banks are awash in ECB loans but also are buckling under the increasing weight of bad real-estate loans.
Lenders are making accommodations to small- and medium-size borrowers that take immediate heat off their customers, but possibly only kick problems to a later date....
Elsewhere in Europe, banks are getting increasingly creative at finding ways to boost their capital ratios without dumping unwanted assets or selling new shares—two of the methods that most regulators and other experts agree are key to fundamentally strengthening the sector.
Some banks are parking portfolios of assets, typically commercial real-estate loans, in newly created off-balance-sheet vehicles. The banks then hire outside advisers such as private-equity firms to manage the vehicles. In some cases, the bank agrees to absorb the first wave of losses on the assets, but the losses or profits after that are divvied up between the bank and the vehicle's manager....
In Spain, nearly every lender has looked at creating versions of such structures, according to people involved in the talks.
But there are potential pitfalls. Regulators at the Bank of Spain are scrutinizing the deals, weighing whether they are appropriate or merely mask risky loans, according to people familiar with the matter.
"I consider such transactions regulatory arbitrage," said a veteran European investment-banking executive who has turned down opportunities to work on such deals.
Falcon Group, a Dubai-based trade-finance company, is working with European banks on a similar type of transaction. It involves bundling portfolios of high-quality loans and then selling the riskiest slices of those loans—the portions that will take the earliest losses—to outside investors, according to Falcon Chairman Kamel Alzarka. The structure is intended to reduce the capital requirements associated with good loans and to avoid needing to sell bad loans at a loss.Otherwise known as creating structured finance securities where the investors have ultra transparency and can see what is happening with the underlying collateral as observable events occur.
Some big banks are devising intermediate solutions that allow them to claim progress at dealing with unwanted loans without having to suffer losses by actually selling the assets at distressed prices.
Royal Bank of Scotland Group PLC recently shifted about £1.4 billion ($2.23 billion) of property assets—nursing homes, parking lots and shopping centers—into a fund run by buyout firm Blackstone Group LP. While the deal generated headlines that government-controlled RBS was disposing of the assets, most of these actually remain on the bank's books. RBS is simply paying Blackstone to manage the assets, with the goal of increasing the odds of the British bank eventually finding buyers.
"This structure is all about getting the expertise of the private-equity fund to get us higher recoveries," said Mark Bailie, co-head of solutions in RBS's noncore division.
Late last year, Spain's largest bank, Banco Santander SA, agreed to sell a chunk of its U.S. auto-finance business to a group of private-equity firms as well as the unit's chief executive. The sale generated a roughly $1 billion gain for Santander, one of a series of capital-raising initiatives by the company.
But there is a catch: the deal isn't necessarily permanent. The buyers have the right to sell back their stake to Santander starting in four years.And this is accounted for when calculating risk weighted assets how?