When Banks Borrow Themselves Into Oblivion

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.

Speaking of predictions, Dr Alex Cowie – editor of Diggers and Drillers – and Kris Sayce – editor of Australian Small-Cap Investigator – both published their final reports for the year this week.

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.

Greg Canavan
for Markets and Money

Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

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11 Comments on "When Banks Borrow Themselves Into Oblivion"

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EU carry is already on …


risk currencies up short term, EURO down suiting the mercantilists and sticking it to the US saying we can do it too GBP us and the Brits in a mess.

Beggar thy liquidity!


We are approaching a Von Mises moment. From the words of the man himself:

“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

I think the latter will be the outcome as no one is willing to take their medicine.

Banks should become nationalized ! But only the Reserve Banks of the world. The reserve banks are the ones that are given the right to print the money supply for entire countries. Only the government should be given the right to do this and not the private banking institutions that own the Reserve Banks. This concept is clearly stated in the US constitution for example and yet private banks have owned the Fed for decades – the exact opposite of what the constitution allows ! Obviously we need a righteous government to administer the reserve bank, but by nationalizing it,… Read more »
Better yet, stop using paper money altogether and rather trade on a daily basis in silver coins, with longer term investments/saving stored as gold and property, etc. This way you will not be affected by inflation as gold always increases in value – at least in the long term and when measured in paper currencies that constantly loses value due to inflation. If you cant stop using paper money altogether in you day to day life, find people who trade in silver bullion coins of various weights and trade with them, while still using limited amounts of silver to trade… Read more »
To Anonymous…does not work. You need to make the whole banking system public (multiple smaller public banks) and ‘own’ the money. The issue is that Central Banks can try and increase liquidity but if private banks will not lend to each other they can print or create money with with as many noughts as they like and sod all will happen – ECB is a great example. All that happens is that banks will not lend to each other (interbank lending collapses) and will deposit the money with the central bank – they, the banks, earn interest for doing bugger… Read more »
So if paper money is the answer then how will you stop central banks from over-printing bank notes whenever they need to “energize” a dead economy ? How will you stop the inflation they cause ? Even if you trust them for whatever reason, how long will they remain trustworthy. Maybe you trust your daily currency or even your life savings in the hands of bankers and politicians, but I certainly don’t. At least if trading in precious metals it put the power back in the hands of the people and you can be guaranteed that you wealth wont slowly… Read more »

In fact if we only used silver, gold or platinum coins to trade with then we could leave all banks privatized – including the reserve banks who would coin this new currency. There would be no way that they could manipulate the economy through inflation and other means.

Let me ask you this: When people first started to trade with others in the receipts their banks gave them for the gold deposited with the banks those banks had called them “promissory notes” because there was a promise on them to pay the bearing in gold upon presentation of the bill. They stopped printing that on their notes and have kept the peoples gold, now they tell us to take these new notes to jewelers or other places to trade them in for gold. We then do that and are satisfied, yet they have still got our gold and… Read more »

It is not just a debt problem that is the cause for all our financial problems – inflation is a hidden tax that can only be eliminated with real money or by forcing banks to backup paper money with real money which is far more challenging than simply using real money to begin with !

Cop this quote I have unwittingly ruined my country.” Woodrow Wilson later said referring to the FED “We have, in this country, one of the most corrupt institutions the world has ever known. I refer to the Federal Reserve Board. This evil institution has impoverished the people of the United States and has practically bankrupted our government. It has done this through the corrupt practices of the moneyed vultures who control it.” Congressman Louis T. McFadden in 1932 The Federal Reserve Bank (FED) is a privately owned company that controls, and profits immensely by printing money through the US Treasury… Read more »

Comment by RodZone Buy gold?.

Not yet.

Good post though.

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