Thursday, December 27, 2012

Are European bank debt funding models broken?

An IMF paper (hat tip The Big Picture) looks at the questions of are European bank debt funding models broken and, if so, how to fix them.

Regular readers know that the answer to these two questions are:  yes, the funding models are broken and fixing them requires the banks to provide ultra transparency and disclose their current global asset, liability and off-balance sheet exposure details.

European bank debt funding models rely to a significant extent on borrowing money in the wholesale unsecured bank debt market.  This funding model failed at the beginning of the financial crisis because nobody could determine which banks that were looking to borrow were solvent and which were not.

Market participants could not make this assessment because bank disclosure leaves them resembling, in the words of the Bank of England's Andrew Haldane, 'black boxes'.

The wholesale market is still struggling to unfreeze due to the lack of transparency.

Unfreezing the wholesale market and fixing the European bank funding models requires the banks provide ultra transparency.  With this data, market participants with funds to lend can assess the risk of banks looking to borrow and can price their exposure to the borrowing banks based on this assessment.

Not surprisingly, the IMF paper never looks at the cause of the European bank funding models failing, opacity, but rather throws out a long list of proposals, like holding more capital and liquid assets, that will do not address the problem of "is the bank solvent".

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