http://www.businesstimes.com.sg/sub/news/story/0,4574,460748,00.html Its all down to Mickey Mouse economics.
Monday, 17 October 2011
So who's right? Do European banks have a solvency problem, meaning they need more capital, or do they just lack liquidity?
According to Nicolas Veron, both. But it all stems from not having enough capital to withstand the inevitable losses on Greek and other sovereign debt.
In Dexia's case, for instance, the availability of funds from the ECB would seem to belie its contention that it only faced a liquidity problem, said Veron, who is a senior fellow at the Brussels-based economic think tank, Bruegel.
"There is a backstop for liquidity. That is the ECB, and it works," he said, while adding that it won't be clear for a few weeks what Dexia's capital and cash-flow situation actually was.
"There is no situation in which banks don't have liquidity," he said, though they do have to pay a higher rate to borrow from the ECB.
At base, "it's a solvency issue," said Veron. "The liquidity issue is all about trust. And trust will not return unless you have stronger balance sheets in Europe generally."
But the answer is not merely to raise the required "capital ratio" - the amount of total capital banks have as compared to the riskiness of their assets. To pass the stress tests, banks needed a 5 per cent capital ratio; now some officials are suggesting it might rise to 9 per cent.
Veron says those capital ratios are meaningless because they don't consider any sovereign debt risk - even Greece's, which it has already been agreed will be at least partially defaulted on.
Ignoring sovereign risk "is a way to say, the unthinkable is unthinkable: Italy will never default on its debt, Spain will never default on its debt, and therefore it's a pure liquidity issue," he said. "One lesson of the crisis is that we have to think the unthinkable."
That would mean coming up with a unified way to assess how risky each European country's debt is - something regulators are now starting to look at.
Q: How has the state rescue of Dexia, the Franco-Belgian bank, affected broader concerns over Europe’s financial sector?
A: If you look at the situation for this bank, it has been pretty poorly capitalised. I would add to the analysis the case of Erste Bank, which, despite all of the sovereign exposure we already knew about, announced there were in fact additional liabilities that we didn’t know about through CDS [credit default swap] exposure [to insuring debt].
Erste used eurozone sovereign CDS as a hedge for bondholders but had not been marking them to market value. The question now is how many other financial institutions are doing the same.
I’ve seen some estimates for outstanding CDS contracts that put the total gross liabilities at €75 billion (£65.7 billion) for Greek debt and €68 billion for Portuguese.
There are still doubts over what is on the balance sheets of European banks, and this has held back investment.
http://www.fundweb.co.uk/fund-strategy/issues/17th-october-2011/the-case-of-dexia-and-what-it-means-for-europe/1039584.article
So who's right? Do European banks have a solvency problem, meaning they need more capital, or do they just lack liquidity?
According to Nicolas Veron, both. But it all stems from not having enough capital to withstand the inevitable losses on Greek and other sovereign debt.
In Dexia's case, for instance, the availability of funds from the ECB would seem to belie its contention that it only faced a liquidity problem, said Veron, who is a senior fellow at the Brussels-based economic think tank, Bruegel.
"There is a backstop for liquidity. That is the ECB, and it works," he said, while adding that it won't be clear for a few weeks what Dexia's capital and cash-flow situation actually was.
"There is no situation in which banks don't have liquidity," he said, though they do have to pay a higher rate to borrow from the ECB.
At base, "it's a solvency issue," said Veron. "The liquidity issue is all about trust. And trust will not return unless you have stronger balance sheets in Europe generally."
But the answer is not merely to raise the required "capital ratio" - the amount of total capital banks have as compared to the riskiness of their assets. To pass the stress tests, banks needed a 5 per cent capital ratio; now some officials are suggesting it might rise to 9 per cent.
Veron says those capital ratios are meaningless because they don't consider any sovereign debt risk - even Greece's, which it has already been agreed will be at least partially defaulted on.
Ignoring sovereign risk "is a way to say, the unthinkable is unthinkable: Italy will never default on its debt, Spain will never default on its debt, and therefore it's a pure liquidity issue," he said. "One lesson of the crisis is that we have to think the unthinkable."
That would mean coming up with a unified way to assess how risky each European country's debt is - something regulators are now starting to look at.
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