Sovereigns and banks can access the wholesale funding markets. And that is both vitally important and remarkable. These conditions resemble those at the start of the financial market crisis in 2008 when uncertainty and risk aversion closed markets down. The lesson then was that access to finance is more important than credit fundamentals. The well-capitalized institution with decent assets will go bust if the market won’t roll over funding.
For now they will, and so there is hope.
Investors, it seems, who generally prefer even the certainty of bad news over the fog of all outcomes being possible, are coping in the absence of a deus ex machina saviour.
And yet: let’s not declare victory too hastily, just because a handful of the world’s strongest banks, such as HSBC and Credit Suisse, were able to launch bond deals in June while Spain, a country with a government debt to GDP ratio of 50%, successfully auctioned some government bonds. If they couldn’t, we would already be in the financial market equivalent of nuclear winter.
We are not, but how far away are we from that?
As market volatility declined towards the end of last month and primary markets reopened to the bigger banks, a curious explanation was being offered for this improved tone. Markets are calming down, participants tell Euromoney, because unlike in the autumn of 2008, they know that governments will always stand behind the banks and bail them out.
Of course, that doesn’t bear scrutiny for more than a split second, given that concerns over banks reignited precisely because of fear of sovereigns being unable to roll over their finances. Are the bankers trotting out such piffle really battle hardened and in control, or are they battle weary and tottering into oblivion?
The Libor-OIS spread might not have reached the peaks accompanying Lehman’s bankruptcy but the signs of funding pressure are evident in growing bank financing through repo at the European Central Bank. Jim Reid, strategist at Deutsche Bank, eloquently expresses the fear that whole swathes of the European banking system might eventually end up heavily reliant on the ECB for funding. It’s difficult to recognize this period we are living through as capitalism.
Ask the banks about the degree of confidence they have in each other and it’s like being transported back in time to the end of 2008. The best managed and most conservative are on the most heightened state of risk alert under which they can operate – conserving cash, limiting exposures – just one step short of that when a large bank failure is in progress.
These are trying times for banks, despite the relief that a round of good Q1 2010 numbers brought to the market. As one chief executive told us last month: “The worst is well behind us. But we remain cautious. We have plenty of money to put to work, but demand for lending in struggling economies is low, and on the other hand we do not want to lend to economies that are in danger of overheating. And one of the biggest problems is that real interest rates are negative. So one of the only places you can put your money to work is in trading.”
All banks proclaim how thoroughly they have de-risked themselves by increasing capital, reducing risk-weighted assets and leverage and building liquidity buffers.
Now the testing time is upon us. Not the official policy-makers’ stress tests, which are due to be published as a confidence-restoring measure. There’s little confidence to be taken in these. It’s not news that HSBC and Santander are in pretty good shape, thank you very much.
They wouldn’t be published at all if they revealed systemic risk and, if their verdict is too sanguine, participants will scorn their credibility. High capital and low leverage is no safety net, if assets are poor. Liquidity buffers aren’t much use either, if they consist of so-called high-quality cash equivalents that turn out to be two- three- or five-year government bonds that have no liquidity. And market makers were clearly holding back at quarter end.
A real liquidity buffer is a laddered portfolio of maturing high-quality assets structured, managed and nurtured so that principal and interest payments deliver dependable volumes of cash to the bank every day. A portfolio of medium-term government bonds is carry-trade investing.
Banks’ second-quarter results are looming. Let’s see what they’ve got.
