Wednesday, April 18, 2012

IMF: EU bank capital related cuts in lending drag on growth

Confirming that EU financial regulators created a credit crunch and slower economic growth with their 9% Tier I capital ratio target, the IMF warned that EU banks under pressure to maintain this capital ratio could cut back further on lending and slow the region's growth.

This is the outcome that your humble blogger predicted when the EU financial regulators announced their 9% Tier I capital ratio target.

This target is meaningless when it comes to any information about the solvency of the banks as both risk weighted assets and bank book capital levels are easily manipulated.  For example, regulatory forbearance results in overstating book capital with the regulators' blessing as losses are not recognized.

According to a Telegraph article,

The decline in credit is a big reason Europe's economy is expected to suffer a mild recession this year and barely grow in 2013, the IMF said in a report on the global financial system released today. 
Large banks based in the European Union may reduce their balance sheets - which include outstanding loans, securities and other assets - by as much as $2.6 trillion (£1.6 trillion) through the end of 2013, the IMF said. That's about 7pc of their total assets.... 
Some reduction in credit, or "deleveraging," is necessary, the IMF said. Banks aren't able to borrow as freely as in the past and governments are requiring them to hold more capital. 
"But like Goldilocks, the amount, the pace of deleveraging must be just right," said Jose Vinals, the IMF's financial counselor. "Not too large or too much."...
The IMF notes that the central bank's capital has given European officials more time to push the continent's shaky banks to raise new capital. The EU's European Banking Authority is already pressing to do that. It has pushed banks to increase the size of their financial reserves compared to their risky loans and investments - but it has urged them to do it by finding new capital, not by cutting back on loans. 
Even so, the IMF points out that most responsibility for overseeing banks remains at the national level, where authorities have been slower to make banks take tough measures. 
Raising capital can be a difficult step because it can dilute shareholders holdings.
Or, as is really the case, raising capital is a difficult step because investors do not want to buy bank equity or CoCo bonds so long as bank financial disclosure results in banks resembling 'black boxes'.

Without ultra transparency under which banks disclose their current asset, liability and off-balance sheet exposure details, market participants do not have the information they need to independently assess the risk of the banks.  As a result, buying bank equity or CoCo bonds is simply blindly betting.
The IMF also warned that national regulators must restrain banks from using money for payouts of dividends to shareholders and bonuses to top bank executives.
This would require the national regulators to abandon the Japanese model for handling a bank solvency led financial crisis and adopting the Swedish model.  Under the Japanese model, losses are only recognized after banker bonuses and dividends have been paid.

Under the Swedish model, all the losses hidden on and off the bank balance sheet are recognized today.  Book capital levels are then rebuilt from retained earnings and banker bonuses paid in newly issued stock. 

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