The tectonic shifts within the eurozones trade balance and capital account are without historic precedent. On the one hand, eurozone policymakers are seeking to craft a banking and fiscal union. On the other, financial protectionism, regulation and the fissures in the cross-border European banking model have triggered a home-bias within the eurozone a form, to use an ugly term, of financial de-globalization.
A chart from Morgan Stanley, published on Wednesday, makes the point.
The funding gap of German banks versus peripheral economies points to balkanization, according to the bank.
In the analysts' words:
|Latest data from the Bundesbank shows that German banks continue to reduce their cross-border funding gaps versus the periphery, having now fallen back to 2004 levels at 227 billion, following a peak of 520 billion in 2008. |
The German retrenchment appears to have affected Spain the most, with cross-border claims having fallen 20% YTD.
The same can be said for French banks, once prominent in European lending (although less granularity in data means we cannot analyse country-specific imbalances) but which have seen their funding gap versus the rest of the eurozone retrace to 2005 levels at 489 billion in May, having peaked at 800 billion in 2008.
Bottom line: We continue to think that the balkanization of European banking markets will act as a drag on lending and economic recovery and be a source of systemic instability. With home nations potentially benefiting from improved credit dynamics at the expense of the periphery, we believe this lends credence to the deepening of fault lines between North and South.For some time the Egyptian authorities have artificially supported the exchange rate but their ability and resources to continue to do so have diminished...
Foreign exchange reserves have been run down by two thirds since 2011 and policymakers can no longer support the currency at current levels...
Hence the authorities manoeuvring room on the exchange rate is rapidly closing.
While parent bank retrenchment in favour of domestic shores has gathered pace within the eurozone, there is more to go. Watch out for the oncoming home-bias of French banks. According to Morgan Stanley:
|French banks have a 450 billion funding gap in the eurozone (outside France), significantly down from over 700 billion at its peak... |
We are concerned that this trend will continue. Bank managements are not openly discussing clear strategies to shrink their cross-border activities within the eurozone, recent banks moves (asset transfers, ECB usage) and declarations (for example, BNPP now saying it is reducing parent funding provided to BNL) support our thesis.
To be clear, we do not think there was anything wrong initially with this funding strategy. However, uncertainty over euro fungibility and regulation is putting more pressure on banks to rebalance their ALM strategies on a country-by-country basis.
Some of the forecasts are scary for the global economy. Morgan Stanley reckons that European banks could deleverage by 1.5-2.5 trillion during the next 18 months. However, "history suggests that, over a longer timeframe say, five to six years this could reach 4.5 trillion assuming zero deposit growth", it says.
No one knows the extent to which deleveraging will gather pace since the impact of regulation and the eurozone crisis on the economics of the global banking model is unclear. In any case, it's important to note that regulators are shooting themselves in the foot. As we have reported, bankers at European institutions, with balance-sheet responsibility at the group-level, fear regulators will take a dimmer view of making European or US balance sheets available internationally in an era of stronger risk-exposure and country-risk limits.
So, yes, the reduction in cross-border lending from credit-worthy banks within the eurozone is both a risk-off correction and a structural re-assessment of business models in light of the eurozones new normal. But, by pushing to reduce the fungibility of capital across borders, ring-fencing liquidity and political pressure to keep capital in domestic shores, dont forget that regulators are adding insult to injury. Talk about pro-cyclicality.