In years gone by it was a real embarrassment for a bank to go cap in hand to its central bank to borrow funds. It was a sign of weakness. Clearly that’s not the case anymore, not in Europe anyway.
Bloomberg reports European banks borrowed €489 billion in three-year loans from the European Central Bank.
‘The perceived stigma attached to central bank borrowing has not prevented euro-zone banks from making extensive use of the ECB’s offer,’ said Martin van Vliet, an economist at ING Group in Amsterdam. ‘The take-up of loans is massive.’
In a normally functioning financial system banks usually manage to fund themselves. At the end of each day, they tally up deposits and withdrawals and work out who has surplus funds and who is in deficit. The deficit banks borrow from the surplus banks at the interbank lending rate to balance the books. Then it’s lights out and everyone goes home happy.
Things get a little uncomfortable if a bank persistently finishes each day with a cash deficit. Its peers become a little suspicious. Perhaps the bank took too much risk and expanded its balance sheet a little too aggressively. Now, it can’t satisfy customer withdrawal requests due to a lack of liquidity. Other banks are no longer prepared to lend to it in case they don’t see their money again. So the bank in question ignominiously toddles off to the central bank for a loan.
That, very simplistically, is how it used to work. That was before easy credit and bank manager brain explosions rendered just about all of the developed world’s banking system insolvent.
Now there’s no shame in heading down to your local central bank for a loan when every other bank is doing it too. It’s probably quite trendy.
But will it actually do anything to help the situation? No. It will merely keep the banks’ nostrils above water. Of the €489 billion in new loans, ‘only’ €193 billion represents new money going into the system. The remainder represents maturing loans from past ECB ‘facilities’. And we thought the ECB wasn’t printing money.
While this sort of liquidity support operation reduces the likelihood of bank defaults in Europe, it doesn’t solve any of the issues facing the Eurozone.
That embarrassment to the great French nation, Nikolas Sarkozy, continues to meddle. He’s encouraging banks to use the proceeds from the ECB, at a cost of 1 per cent, to invest in higher yielding southern European bonds. In his mind, this would lower sovereign borrowing costs, take pressure off the banks and increase the chances of his re-election next year.
The banks are having none of it though. Peripheral debt yields rose overnight as insolvent lenders shied away from giving newly conjured money to insolvent borrowers. Equity markets declined. It looks like the lending ‘sugar rush’ is over already.
We’re not sure how long this Euro circus can continue. But we do know it is virtually impossible for the Eurozone to hold together in its current form. The problem is a lack of competitiveness.
Southern Europe needs to devalue/deflate their economies by around 30 per cent to regain competitiveness with the north. Otherwise the Euro is just too strong for them to compete. Expecting such an internal devaluation to happen without a breakup is crazy.
So, here’s a fearless prediction to look out for in 2012 – expect one or more countries to exit the Eurozone.
Their fearless predictions for 2012? Both reckon it’s going to be a good year to buy stocks at the smaller, more speculative end of the market. Granted, a year is a long time. They’re not saying to load up on 1 January and count your winnings on 31 December.
The general vibe from these gentlemen is that we’re in for a lot more volatility. And if you’re cashed up and ready to pounce, you could be counting your profits sometime in 2013 or beyond.
We also finished the final Sound Money. Sound Investments report for the year yesterday. In it, we explained why the economic cycle (as you know it) is dead and how investment strategies need to change to deal with this reality.
for Markets and Money