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| Angela Merkel |
In theory, any boost to banks’ capitalization should enhance their credit metrics and make their bonds more appealing to credit investors. But the great bank recapitalization plan unveiled at the European heads of state summit in Brussels at the end of October won’t do much to halt the slow-motion run on bank funding that has been unfolding since the summer. The headline figure of €106 billion is much lower than the €200 billion to €300 billion recapitalization being widely discussed just a few weeks ago. Looking into the details of the plan, it soon becomes clear that the actual amount of capital to be raised is much lower even than this. The biggest capital shortfall calculated by the EBA is €30 billion for Greek banks. This has already been set aside in earlier bailout packages for that country. Similarly the €8 billion shortfall for Portuguese banks will likely be met out of the IMF funding vehicle already established for this; another €7 billion for Volksbank and Dexia is already accounted for.
Allow for the conversion before next October of €10 billion of mainly Spanish bank convertibles already outstanding. Take out say €6 billion because the EBA has applied market prices on government bonds prevailing at the end of the third quarter to banks balance sheets as they stood back at the end of the second quarter, since when they have shrunk. Factor in a roughly €25 billion boost to capital from retained earnings and reduced dividends, and the final capital shortfall for European banks comes out at maybe €20 billion.
No wonder that, after running these calculations, analysts at Credit Suisse conclude that this is not really a bank recapitalization at all.
Why have European regulators come up with such a flimsy plan? Perhaps because they know private investors are very unlikely to provide more capital and fear having to step into the breach themselves. Presumably also because they do not want to provoke a further disorderly deleveraging by banks that can’t raise new equity and a sell-off of assets that prevents banks from lending to the real economy in Europe even as it weakens next year. They want to preserve banks’ ability to lend to another group of borrowers most dear to policymakers’ hearts: governments themselves.
This, of course, is where it all gets rather tricky. Sensing that investors in bank debt will be underwhelmed by their recapitalization plan – especially because it only makes allowance for banks to recapitalize to 9% tier-1 ratios after taking hits on sovereign bonds but not also for hits on bad loans amid the recession investors now fear – policymakers have scrambled around for anything else to ease banks return to the funding markets.
Sadly, all they have managed to come up with is a vague plan to reintroduce government guarantees on term funding. This is supposed to follow a co-ordinated EU-level approach on entry criteria, pricing and conditions for government guarantees, instead of the full national discretion with which governments set up bank liquidity schemes in 2008.
This does not sound terribly convincing. German taxpayers are unlikely to take kindly to their government guaranteeing the liabilities of French, Spanish or Italian banks, if German banks don’t need guarantees to raise funds. On their own, weaker government guarantees are next to worthless. They will be expensive for banks already struggling with high funding costs. They will only add to troubled sovereigns’ contingent liabilities, so further weakening their debt to GDP ratios. And investors won’t take much comfort from them, given sovereign stresses. So bank funding costs won’t come down much anyway.
Nothing can change the fact that we are now living through a sovereign crisis that has infected the banks.
Talking to investors in bank debt and equity throws up another reason why the third version of the EBA stress test and its associated recapitalization plan won’t win them round to funding banks at low cost. Investors’ faith in bank regulators is about as sturdy as their faith in ratings agencies after they gave triple-A ratings to the super-senior tranches of bonds from highly correlated CDO portfolios of sub-prime mortgage backed bonds. It is close to zero. Investors cannot take seriously a coven of regulators that has conspired to maintain the fiction that government bonds on bank balance sheets deserve the lowest risk weightings. Investors lay a large part of the blame for the latest poisoning of bank balance sheets at the regulators’ doors.
Whatever confidence trick banks and regulators come up with next, investors are no longer paying attention. They are taking a much closer look at the long-term sustainability of bank business models after allowing for reduced access to wholesale funding at higher cost. And they are making binary choices. For banks with unsustainable models, funding won’t be available from the private market at any price.
