A knot in the money pipe
Jan 13, 2012
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The financial system should be “a frictionless conduit” for money, says The Economist. But the eurozone is now “a hosepipe with a knot in it”. The European Central Bank (ECB) has pumped unprecedented amounts of liquidity into one end of the pipe, “but how much of that will find its way to the parched real economy is another question entirely”.
Thanks to fears over banks’ huge exposure to dodgy European sovereign debt and the €1.7trn of bank funding that must be rolled over in the next three years, there has been “an almost total freeze” in the bond markets since the summer. Meanwhile, the freeze in the interbank markets shows no sign of thawing.
While the ECB lent out €489bn in three-year money last month, much of this has flowed back to the central bank. Commercial banks’ overnight deposits at the ECB have exceeded €460bn. The ECB pays less interest on overnight deposits than banks could earn by lending on the interbank market. This shows that “many institutions still lack enough trust to lend to each other”, says Reuters.com.
Another factor behind the ongoing hoarding is that banks are obliged by the European Banking Authority to raise their core capital by €115bn to boost their capital ratios to 9% of assets. Given raising money is extremely difficult in these markets, most will meet the new ratio target by ditching assets. This implies “gut-wrenching deleveraging”, says Walter Molano of BCP Securities. Balance sheets will shrink by around $2trn.
Over the past few days it has become increasingly clear that raising capital will be nigh on impossible. Shares in Italy’s Unicredit have tanked as investors have baulked at participating in a rights issue, despite the 43% discount to last Wednesday’s price. Other banks will also struggle, says FxPro.com. Spain’s “look to have a real mountain to climb”. Around 50% of all property-related loans are “already either bad… or underperforming”.
Unicredit’s experience reinforces fears of balance-sheet shrinkage, which will “merely intensify the mother of all credit contractions”, says FxPro.com. That in turn will further undermine eurozone growth, which will soon turn negative, fuelling even more concern over bank and sovereign balance sheets. This destructive vicious circle means the debt and banking crisis is set to get even worse.
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