European Banking – It Is Getting Scary

The past week was not only characterized by US equity markets making one all-time high after another. Much less excitement was associated with one frightening message after another related to the state and prospects of the (European) banking sector.

On Thursday, Reuters announced that G7 finance chiefs are coming together to discuss a bank reform push. We do not know the real agenda and underlying motives of the G7 meeting but put in our own simple words: this stinks. Reuters writes: “Some of the world’s most powerful finance chiefs will meet on Friday and Saturday to try to speed up banking and finance reforms, with Cyprus’ near meltdown fresh in their minds.” Today, Saturday May 11th, a reaction appeared on Reuters in which the German finance minister points to Japan being the big risk. Weren’t the talks supposed to be about the banking reform in Europe? Apparently there is something worse going on which is revealed by the title of the piece euro zone crisis no longer main risk to the global economy. So we were correct when we wrote back in February that the currency war had officially started with Japan’s announcements about their monetary stimulus.

Earlier this week, Iris Times wrote that Ireland which has the presidency of the European Council, will propose the ‘bail-in’ of large depositors in case of European bank collapses. “Discussions on the controversial bank resolution regime, which is likely to see savers with deposits over €100,000 “bailed in” as part of future bank wind-downs, are due to intensify this week in Brussels, ahead of Tuesday’s meeting, which will be chaired by Minister for Finance.”

The following quote proves there is almost a full consensus among European leaders about the bail-in confiscation of its citizens. A German site reported the following (translated):

Part of the ECB, the EU and central banks agree when it comes to depositors’ role in saving the European banks. Jörg Asmussen (…) made clear in the EU Parliament they will “obtain” access to savings account holders.

Based on the lessons learnt from Cyprus, Asmussen believes “we urgently need a European framework for the operation of financial institutions.” This framework should contain some rules related to refinancing of banks by their depositors. Asmussen points to bail-in rules, the possible confiscation of assets and preferred creditors.

So we should have had trust in Mr. Dijsselbloem’s statement when he said that Cyprus was a template for the future, although he admitted the day after not knowing what the word “template” means (source). Good citizens should have confidence (emphasis added) in their leaders, right?

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On a more serious note now. All the evidence is there. Cyprus was indeed a “pilot” to determine the resistance against a bail-in from savers. Apparently the reaction of the Cypriot people and savers in the rest of the world, was too weak. The path of less resistance was the most likely one for decision makers.

This is truly frightening. Up until this point the suspicion was too high to ignore but still – let’s be honest – we all somehow hoped this was not true. So far our hope.

Now this brings up the question what exactly is going wrong with the banking system. It is a fact that banks can borrow at almost zero percent interest from the central bank and lend out at 4 to 8 percent (applies for most loans). Apparently this cannot make up for the damage. It is a fact that banks had got unprecedented amounts of liquidity to recapitalize themselves. It did not bring a solution neither. So then what is the real problem?

Clearly the core business of banks (i.e., creation of credit) is not growing. Rather, in Europe and the US, it seems like particularly private sector credit is contracting. Only the US has a small growth in credit their expansion (although apparently driven by consumer loans and car loans according to Zerohedge).

credit monetary base march 2013 gold silver insights

It was Bundesbank President Jens Weidmann today who reiterated that monetary policy cannot tackle structural problems and said the longer the period of low interest rate continues the greater the stability risks (source: Reuters).

With the disclosure of not being experts in the matter but only observers, we believe it is reasonable to assume that the banking sector is still being confronted with structural problems, which were not solved after the 2008 collapse followed by unprecedented liquidity. It seems very likely to us that insolvency of an overleveraged banking system is the core of the issue. Too much debt. And the issue clearly became worse since 2008.

By the way, in case readers missed this, Reggie Middleton’s research shows that the Irish banking sector is the next one … to be bailed out or get Cyprus’d.

Please feel free to participate in the discussion by leaving a reaction in the comments below. Our site has a very international audience. Do not hesitate to express your thoughts, even if not your native language is not English, as this topic is critical for all of us!

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