[it] is in a terrible state, and nothing much is being done about it.But the problem doesn't end with the global financial system. It extends to the global economy.
Regular readers know that policymakers and financial regulators chose to pursue the Japanese Model for handling a bank solvency led financial crisis. Under this model, bank book capital levels and banker bonuses are protected at all costs.
The costs of this protection include transferring the burden of the excess debt in the financial system onto the real economy where it diverts capital needed for reinvestment, growth and supporting the social programs to debt service.
The result is economic malaise and re-writing the social contract.
Regular readers also know that there is a proven solution for handling and ending a bank solvency led financial crisis: the Swedish Model. Under the Swedish Model, banks are required to recognize upfront their losses on the excess debt in the financial system. This protects the real economy and the social contract.
Our modern banking system is designed to support adoption of the Swedish Models. Specifically, banks are capable of continuing to support the real economy even when they have low or negative book capital levels.
Banks are able to continue in operation because of the combination of deposit insurance and access to central bank funding. With deposit insurance, taxpayers effectively become the banks' silent equity partner when they have low or negative book capital levels.
The zombie banks and economic destruction caused by these banks that the Economist finds are the result of pursuing the Japanese Model.
Banks are central to Europe’s prospects.Since banks are central to Europe's prospects, it is important to understand how they are designed and to realize that the designers understood that there would be a time when excess debt once again existed in the financial system.
So the choice to have zombie banks is entirely the policymakers and financial regulators.
The fear, especially in peripheral economies, is a repeat of Japan’s experience in the 1990s, when “zombie” banks staggered along for years, neither healthy enough to lend to firms nor weak enough to collapse.Given that global policymakers and financial regulators chose to pursue the Japanese Model, it is guaranteed that Japan's experience with zombie banks would occur in the EU, UK and US.
There are the same unvital signs in Europe. The average price-to-book ratio for European banks remains below one, suggesting that investors think lenders are worth more dead than alive....
Weren’t the Europeans supposed to be cleaning up their balance-sheets?...
Regulators worry that banks, rather than writing off or selling bad loans, have been fiddling with the models that dictate how much capital they need to hold. Danske Bank, a big Danish lender, was abruptly ordered by its supervisor to change its calculations last month, lowering its capital ratio. Denmark is outside the euro, but even German politicians joke about the nasty surprises in their banks’ balance-sheets.
None of this presages a full-scale collapse: European banks have more capital than they did before the start of the crisis. But lending is being throttled....All of this applies in the UK. In the US, price to book is slightly higher, but these banks aren't lending either.
Please note that while lending is being throttled, banker pay has not been.
The second cure involves lifting the cloud of suspicion over European banks.
The ECB will undertake an “asset-quality review” before it takes up the role of euro-zone banking supervisor next year.
Previous stress tests by national supervisors were not tough enough—and convinced nobody.
The asset-quality review is the ECB’s first and best chance to establish its credibility.
Banks that fall short must be recapitalised—by raising fresh equity from private investors, by bailing in creditors and, in some cases, by bringing in public money.An asset-quality review suffers from the same problem as a stress-test. Nobody believes the results.
Ireland did both with its banks and nobody believes the banks are solvent. Greece and Spain have also done asset-quality reviews and stress-tests.
The reason that asset-quality reviews and stress-tests are not believable is that they are not accompanied by the requirement that banks provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.
Ultra transparency is needed so that market participants can independently confirm the results of the asset-quality review and stress-test.
Without the ability to independently review the results, a big red flag is waved in front of the market participants that says don't trust the results.