Photo: Dan Moyle / Flickr
Everyone’s been jabbering about rising yields on sovereign bonds and the execution of the Greek bailout, but this might be overlooking the most pressing problem:The European banking system.
We’ve been talking about the banking system on and off since the summer, but the growing liquidity crisis in European banks has remained under the radar recently. That all could be about to change.
With banks forced to raise more capital as they report massive writedowns and big losses, their liquidity situation is growing ever tighter. And that could make the euro crisis even worse.
Let’s take, for example, take a look at the case of UniCredit, a troubled Italian bank that reported big losses today. This is part of their strategic plan:
AROUND 11% OF JUNE 2011 GROUP RWA RINGFENCED AND RUN-OFF TO SUPPORT THE BEST CAPITAL EFFICIENCY
[They elaborate on how this will happen]…Proactive balance sheet management and ring-fencing of non-core performing assets in a €43bn (RWA) run-off portfolio. With around 80% of the portfolio expected to run-off by 2015, the ring-fencing initiative will free-up substantial capital and liquidity during the Plan’s implementation period
In other words, the bank plans to turn some €43 billion ($58.6 billion) in risk-weighted assets into core capital once they mature. The vast majority of lending is “risky,” so this essentially amounts to a decrease in lending to other banks.
Aside from the credit crunch this would engender for private sector borrowers, such behaviour also causes a liquidity crisis when banks across the board stop lending to one another. There’s ample evidence to prove that this is, indeed, what’s going on.
Reuters’s Felix Salmon points to the 3-month Euribor (unsecured term lending) to Eonia (unsecured overnight lending) spread as a good indicator of funding pressures on European banks. That spread—with more relative than absolute accuracy—is heading skyward.
Salmon argues that this supports evidence that most European banks are under funding stress, but that only Greek banks are currently insolvent if you mark their exposure to market:
Mark French banks’ holdings of Italian sovereign debt down by say 10%, and they’re still fine; their capital drops, of course, as it would with any write-down, but certainly to nowhere near zero.
The heart of this ongoing problem, he says, is the failure of the European Central Bank to step in and take an active role:
What is true is that Europe is in the middle of a textbook liquidity crisis. Banks are not lending to each other — and the ECB isn’t stepping in to solve the problem. This is a serious structural issue with the way that the European monetary system was constructed: the ECB is tasked only with guarding inflation, and not with ensuring the health of the banking system. Individual national central banks are meant to do that. But they can’t print money — only the ECB can. So when there’s a liquidity crisis, no one’s able to step in and solve it.
At the end of the day, the banking system is as crucial to the success of the eurozone as the size of sovereign debt—if not more so. If banks are unwilling to lend, then they are as unlikely to lend to sovereigns (other than AAA-rated Germany and France) as they are to businesses. So liquidity tightening not only harms private growth that would increase tax revenues, it hinders sovereigns’ ability to access private cash.
This is a crisis being generated by market fears, not about the reality of whether Italy and Spain are able to pay back their debt. Fear begets fear in Europe, and the banking sector is at the heart of that.