Tuesday, June 20, 2017

Waiting for Godot or Does Anyone Really Know What Is Going on with eurozone Banks?

I have been researching eurozone banks excess reserves and repo availability for a few weeks trying to work my way through muddled commentary and sort the reality from the assumptions and found myself questioning what I know.  In doing so, I have misstated to others what I am thinking and even the data, facts, and issues about which I am concerned.  Sometimes it is best to just stand back and look for the string that pulls the material together.

I have yet to write that article which will address whether eurozone banking rules to promote solvency of banks is creating a liquidity problem, because  the eurozone banking resolution authorities seem to have so badly mismanaged the Banco Popular resolution to the point of intensifying a bank run despite monitoring bank liquidity on a daily and hourly basis.

Banco Popular was Spain's 6th largest bank having been in existence since the early 20thCentury and one of the more profitable banks until about 2016.  In February 2017, it announced it had a 3.b billion euro loss on asset writedowns and Non Performing Loan sales while maintaining it still had more than sufficient quality assets on its balance sheet.

By the end of May and first days of June reports were circulating that Banco Popular had received only 3.5 billion euro on 40 billion euro collateral rather than the 9.5 billion euro it had expected one month previously and had applied to the Bank of Spain for liquidity support receiving only 10%

of the collateral it pledged drawing 2 billion and 1.6 billion euro which it managed to burn through in just a few days.  Banco popular had been down rated by all foud major credit rating agencies between April and the 19th of May causing institutional clients with minimum credit requirements for banking to start withdrawing deposits during as period when the bank was trying to receive bids to privately resolve though a sale of the bank.  But on May31st, an anonymous EU official leaked to Reuters that an "early warning" had been issued.  This was followed by an immediate denial by the Single Resolution Board, which would have been the entity issuing such an early warning.  As a consequence, it experienced 20% daily drops in stock value on June1, 5, and 6 and by 6th June had supposedly endured (never publicly verified yet) 18 billion euro deposit outflows.  While this may have been, according to EuroIntelligence, someone going to the press because the Single Resolution Board had communicated to the Single Supervisory Authority it was going to initiate early intervention measures, the communication to Reuters was the early warning had been issued, although, according to FROB (Spain's resolution authority), the Single Resolution Board had notified them on June 3 of their intention to act.

This had caused some people to postulate that the eurozone bank resolution mechanism actually encourages bank runs.

Additionally, the valuation of Banco Popular subsequently commissioned by the Single Resolution Board found a negative 2 billion euro to a negative 8 billion euro in a stressed scenario.  Banco Popular was considered solvent immediately prior to this meeting its minimum regulatory capital requirements and a positive value of 11 billion euro, which would a 20 billion euro difference in value. This has caused many people, including Bank of Spain supervisors, to question and demand to know how those figures with such a huge range were determined adding to the controversy over whether this was an actual solvency crisis or rather a liquidity crisis caused by the valuation of its collateral by the bank of Spain and the ECB and the refusal of the Spanish government to defy eurozone authorities and aid a private resolution.

Banco Popular was sold for 1 euro to Santander further consolidating banking in the eurozone, which raises the issue of the eurozone bank resolution process creating large, systemically dangerous banks in the eurozone.

For several years I have communicated privately that I believe any euro crisis will start in Spain and spread to Italy, which would be the keystone.  I have come to believe it will not happen quickly but accumulate momentum over time.  The ECB worked very hard a few years ago to strengthen the asset quality of Spanish banks and stabilize the Spanish banking system, while Italy had reorganized it's small state banks prior to the Great Financial Crisis (Spain had not).

Consequently, let us look at Italy and the problems with Banco Popolare di Vicenza and Veneto Banca --- as the problems with Monte dei Paschi di Siena (the oldest bank in Europe) are well known.

The Italian government has been actively seeking to resolve the two banks through a precautionary recapitalization based on the December 2016 legislative decree used to enable a precautionary recapitalization and liquidity support to Monte dei Paschi.and official statements.  The Italian authorities have talked with several large Italian banks, although it appears to be devolving down to Intesa  Sanpaolo.  Veneto Banca will have a 85 million euro payment on a subordinated bond due on 21 June 2017 delayed until mid-September as a result of the legislative decree, because both banks need a total of  6.4 billion euro in capital while they try to sale bad debts and because the Italian government and the European Commission have been been debating for months  the European Commission's demand that private investors put 1.25 billion euro in both banks before any taxpayer money can be used.  This European Commission demand has held the precautionary recapitalization from proceeding.  It appears that a consortium of banks and private investors have rejected the European Commission demand and the Italian government is no looking for a good bank.bad bank split and sale of the good bank for 1 euro as no willing buyer wants to take on the non performing loans. 

Under eurozone bank resolution you have the choices of private recapitalization, private sale resolution, good bank/bad bank, or liquidation.  If the European Commission is going to continue to insist on the 1.25 billion euro private investment in the two banks to permit Italy to use taxpayer money, the possibility of creating a bad bank becomes much more difficult.  The only way I see it happening is if the Italian authorities either arrange the private investment to happen or if the Italian authorities defy the European Commission and act consistent with the 23 December legislative decree. 

If this fails, it will only feed the anti-euro political climate in Italy, which is already looking at elections next year and the possibility of a more right wing government coalition of Berlusconi and Renzi.  The what happens in the eurozone?  And with eurozone banks?

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