Britannia Radio

Jeremy Warner

Jeremy Warner, assistant editor of The Daily Telegraph, is one of Britain's leading business and economics commentators.

As stock markets plunge anew, 

sovereign debt threatens 

secondary banking crisis

 

By Jeremy Warner Economics 

Stock markets are in trouble again. The FTSE100, for one, plunged back through the 5,000 barrier this morning, taking it back to where it was last August. You don’t have to look far to see why. The worst affected sectors are banks, oils and mining. Oil and commodity prices are falling because of fears about a double dip recession; banks are slumping anew for much the same reason.

With banking there is a simple, arithmetic relationship between the level of economic activity and bad debt experience. As a crude rule of thumb, every one percentage point of contraction in the economy will result in a roughly equivalent impairment in the value of assets. Despite all the government money thrown at the problem, capital in the banking sector has barely recovered from the last, sub-prime and recessionary hit to its integrity. Now there is every possibility of a fresh round of bad debts.

In its last Global Financial Stability Report, the IMF reduced its estimate of prospective bank write-downs and loan loss provisions in advanced economies for the 2007-10 crisis and recession from $2.8 trillion to $2.3 trillion, of which the GFSR estimated that approximately two thirds had already been recognised. Note however, that these are the write-offs the IMF thinks appropriate for the last crisis. They say nothing about a new one.

Already interbank lending rates – the rates at which banks lend to each other – are back at elevated levels. True enough, spreads are not yet nearly as wide as they were in the immediate aftermath of the Lehman Brothers collapse, but after a brief return to normality, they have been moving steadily higher for some months now. Those banks flush with excess deposits, such as HSBC, are again being extra careful who they lend to.

Nor is this just about the sovereign debt crisis in the eurozone, though plainly it doesn’t help matters. German and French banks are particularly exposed to Greek sovereign debt. If you include Portugese and Spanish debt, then exposures are bigger still.

But the wider concern is that the austerity being demanded of all economies in Europe will tip them back into recession and thereby cause a new round of conventional bad debts. Liquidity is being withdrawn in anticipation.

Just as everyone thought the banking crisis largely over, it threatens to begin anew. The banking crisis helped prompt a sovereign debt crisis, which now threatens to reinfect the banking sector with a secondary bad debt experience. Markets are beginning to believe there is no way out. More worrying still, few if any can afford another round of bank bailouts. At the weekend, Spain was forced to come to the rescue of another of its regional banks, CajaSur. How many more of these overexposed mini-banks will the Government have to bail out, and can Spain’s already stretched public finances afford it? Unsurprisingly, the markets are doubtful.

There’s still room for confidence to revive and the problem to go away, at least for the time being. But it’s not looking good, not good at all.

Tags: banking crisis, double-dip recession, Global Financial Stability Report, imf, sovereign debt crisis, stock markets