Wednesday, April 18, 2012

IMF fears $3.8 trillion forced asset sale by EU banks

Highlighting the hazard of the regulatory fixation with meaningless bank capital levels and capital ratios, the IMF suggested in its Global Financial Stability Report that EU banks face risks that may force them to liquidate $3.8 trillion in assets by the end of 2013.

Readers will recall that the OECD called bank capital levels and capital ratios meaningless.  This reflected the current complete lack of informational content in either bank capital levels or capital ratios and the degree of ease with which both can be manipulated with the blessing of the financial regulators by the banks.

Despite the fact that bank capital levels and capital ratios are meaningless at conveying any information about the solvency of the bank, the focus on them by regulators creates the situation where a fire-sale of high quality, performing assets might occur.

According to a Telegraph article,

An escalation of the eurozone debt crisis could force European banks to sell assets worth up to $3.8 trillion by the end of 2013 with damaging consequences for the global economy, the International Monetary Fund has warned. 
The IMF's spring Global Financial Stability Report said that should markets lose faith in the effectiveness of eurozone policies, rising funding costs and increased stresses within the banking system could force banks to rapidly reduce their balance sheets to raise capital buffers.
The sell-off among 58 of the biggest banks in the European Union included in the IMF's analysis would be equivalent to 10pc of total assets, and the balance sheet adjustment would also involve a significant reduction in bank lending, it said....

Note, the rapid sell-off is a consequence of the need to rapidly raise capital buffers.

This assumption is flat out wrong.  As shown by the US Savings & Loan crisis, banks are fully capable of operating for years with a negative book capital level and making loans to support the real economy.

There is no need to rush to restore bank book capital levels either through asset sales or government provided recapitalization.

"Such a large-scale deleveraging would have consequences well beyond the euro area. The fire sale of bank assets could have a significant impact on asset prices and market liquidity," the IMF said....
Confirmation of these consequences is easily seen by looking at the impact of the EU financial regulators setting a 9% Tier I capital ratio for June 30, 2012.  The EU is currently experiencing a a credit crunch in addition to seeing a negative impact on asset prices and market liquidity.

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