The sovereign bank cycle in Europe will not die — chart via the Morgan Stanley analysts Huw van Steenis and Alice Timperley:
The long-running mechanism here is that sovereign risk has left peripheral banks unable to raise funding without prohibitively high rates, and it’s getting worse the more banks see loan destruction and a deflationary spiral looming in southern Europe. Morgan Stanley has been pointing to the latter quite a lot recently.
But there is something changing, suddenly, and it’s do with banks raising capital as a circuit-breaker to funding. It’s not just about how much is being raised — but who is pushing the banks to do it.
Morgan Stanley notes the issue by way of pointing out another reason that last year’s EU bank stress tests were absolutely rubbish and/or overtaken by reality:
The tests did not address the feedback loop of higher cost of wholesale funding and deposit wars on Southern/peripheral [lenders], and many Southern banks are already earning less than the adverse case…
But this is the key point:
The pace of capital raising has picked up due to national policy activism. So far we have seen €34.1bn this year and €54.9bn since the stress tests. We think the equity and credit markets have underestimated the desire of some policy makers to drive more bank capital to reduce economic risk. At our conference 1/3 of investors thought only €20- 30bn of bank equity would be raised post conference into year end, and yet in 3 weeks since the conference €23.3bn of raising has been announced. We think there is more momentum to this process.
It has indeed been very idiosyncratic. For example, Italy is using Basel III to induce banks there to recapitalise, Spain is focused on the cajas. While more capital is good, we’ve got one question: isn’t this a giant co-ordination problem in the making?
If one national recapitalisation goes wrong, contagion spreads to the others via funding.
In a way it is effectively the giant periphery-wide recapitalisation of banks that many had been calling for all along. However, it was usually also argued that there was no real point asking individual sovereigns themselves to recapitalise banks at this late stage.
Firstly, they’d fail to exert enough pressure on banks to make them recognise or write down bad assets beforehand, to ensure that capital wouldn’t vanish into a black hole. Second, and generally because assets hadn’t been written down, sovereigns would have to inject capital themselves if private investors stayed away. They wouldn’t be able to afford this, so eventually the sovereigns would collapse.
One has already. This is the story of the Irish crisis.
So you can see why we’re a bit “once bitten, twice shy” regarding ‘national policy activism’ on capitalising Europe’s rubbish banks.
Is the case for a Europe-wide Tarp scheme (and a Europe-wide bad bank, and funding for restructuring banks, and so on) – still out there?