The retreat from financial integration has been encouraged by bank regulators.
For example, the UK Financial Policy Committee asked UK banks to lower their exposure to a break-up of the eurozone. As a consequence, banks have either reduced their exposures to the eurozone or tried to match fund their assets in a country with deposits from that country.
Regular readers know that this policy encouragement is just a continuation of the Japanese model for handling a bank solvency led financial crisis under which bank book capital levels are protected at all costs.
It is the pursuit of the Japanese model that is triggering the problem.
Specifically, in protecting the French, German and UK banks from taking losses, the Eurozone policymakers have managed to a) socialize the losses and put them onto taxpayers, b) inflict significant damage to the real economies of the peripheral countries and c) trigger bank runs in the peripheral countries.
All of these 'achievements' could have been avoided if policymakers had not chosen to protect bank book capital levels and by extension banker bonuses at all costs.
As shown by Iceland, by making the banks absorb the losses, damage to the real economy is minimal.
An accelerating flight of deposits from banks in four European countries is jeopardizing the renewal of economic growth and undermining a main tenet of the common currency: an integrated financial system.
A total of 326 billion euros ($425 billion) was pulled from banks in Spain, Portugal, Ireland and Greece in the 12 months ended July 31, according to data compiled by Bloomberg. The plight of Irish and Greek lenders, which were bleeding cash in 2010, spread to Spain and Portugal last year.
The flight of deposits from the four countries coincides with an increase of about 300 billion euros at lenders in seven nations considered the core of the euro zone, including Germany and France, almost matching the outflow. That’s leading to a fragmentation of credit and a two-tiered banking system blocking economic recovery and blunting European Central Bank policy in the third year of a sovereign-debt crisis.
“Capital flight is leading to the disintegration of the euro zone and divergence between the periphery and the core,” said Alberto Gallo, the London-based head of European credit research at Royal Bank of Scotland Group Plc. “Companies pay 1 to 2 percentage points more to borrow in the periphery. You can’t get growth to resume with such divergence.”
The erosion of deposits is forcing banks in those countries to pay more to retain them -- as much as 5 percent in Greece. The higher funding costs are reflected in lending rates to companies and consumers. ....
The ECB has taken the place of depositors and other creditors who have pulled money out over the past two years, largely through its longer-term refinancing operation, known as LTRO.
The Frankfurt-based central bank was providing 820 billion euros to lenders in the five countries at the end of July, data compiled by Bloomberg show. Irish and Greek central banks loaned an additional 148 billion euros to firms that couldn’t come up with enough collateral to meet ECB requirements.
Because central-bank financing is counted as a deposit from another financial institution, the official data mask some of the deterioration. Subtracting those amounts reveals a bigger flight from Spain, Ireland, Portugal and Greece. For Italian banks, what appears as a 10 percent increase is actually a decrease of less than 1 percent.
When financing by central banks isn’t counted, the data show that Greek deposits declined by 42 billion euros, or 19 percent, in the 12 months through July. Spanish savings dropped 224 billion euros, or 10 percent; Ireland’s 37 billion, or 9 percent; Portugal’s 22 billion, or 8 percent.
The pace of withdrawals has increased this year.
Spanish bank deposits fell 7 percent from the beginning of January through the end of July, compared with a 4 percent drop the previous six months. The decline in Portuguese savings accelerated to 6 percent from 1 percent, while Irish deposits fell 10 percent compared with almost no change in the last six months of 2011....
ECB cash may have plugged holes at lenders that otherwise would have had to sell assets at fire-sale prices as they lost private financing. The aid didn’t prevent funding costs from rising for the rest of the banks’ borrowing, including deposits....
Another blow to financial integration is the localization of borrowing and lending.
Units of German, French and Dutch banks in Spain, Italy and other peripheral countries also borrowed from the ECB to reduce the need for funds from their parent companies. Deutsche Bank AG, Germany’s largest bank, said last week it had cut the reliance of units on financing by the Frankfurt-based firm 87 percent through ECB loans.
While the largest banks say they’re protecting themselves against currency redenomination in case a country leaves the union, such moves help exacerbate divisions between the periphery and the core. A locally financed Deutsche Bank unit can’t make loans that reflect the cheaper funding sources of its parent in Germany.
By taking over the financing of weak banks, the ECB is in effect bailing out their creditors in the core, according to Edward Harrison, an analyst at Global Macro Advisors, an economic consulting firm in Bethesda, Maryland.
If Irish or Spanish lenders burdened with losses from their nations’ housing busts were allowed to fail, German and French banks would lose money on loans to financial institutions in Europe’s periphery.
The ECB’s latest plan to buy the sovereign bonds of some countries will continue the trend of bailing out German and French banks, Harrison said.
“The leaders of the core countries won’t let the periphery countries write down their debt because then they’d have to capitalize their own banks losing money from those investments,” Harrison said. “This is a good backdoor bailout of their banks, but it still doesn’t solve the solvency issue of Spain or Italy.”
The rescue shifts default risk from private shareholders of core banks to the ECB and, in effect, to euro-area taxpayers.....