Spain's Banking System Woes Revisited

As we have mentioned in yesterday's 'Odds & Ends' on the euro area, Spain's banks are now supposed to lend money to the regions. This is like a blind guy asking another blind guy to be his guide when he climbs the Eiger north face. As financial creativity goes, it is a truly audacious stunt even by Spain's standards.

Keep in mind here that a euro-group bailout for Spain's banks has already been agreed upon – so it seems as though this has now been unilaterally transformed into a combined 'banks and regions' bailout.

Bloomberg reports that the Spanish banks are 'bleeding cash' and that this has 'clouded' the bailout debate. No sh*t, Sherlock.

Interesting is a comment on the exit of deposits, which confirms what we wrote back in late August: some of the deposit flight has indeed to do with securitizations and SPV's, which are not allowed to keep their cash with banks that fall below certain ratings thresholds. There are a few more comments in the Bloomberg article worth relaying, and we reproduce the most important points below:


On loan-deposit ratios and the possible imposition of limits:


Governments must first seek wider help from Europe’s rescue mechanism before the ECB will buy bonds. Moreover, the terms of Portugal’s May 2011 bailout require its banks to achieve a loan- to-deposit ratio of 120 percent by the end of 2014, while Ireland’s deal demands a ratio of 122.5 percent by 2013. No such provision was included in the July memorandum of understanding for Spain’s bank bailout.

“The first consequence of a lower loan-to-deposit ratio being set is that you have to identify chunks of assets to sell and that inevitably leads to haircuts and capital implications,” said Eamonn Hughes, an analyst at Dublin-based Goodbody Securities. “It also forces you to pay up for deposits, as we have seen in the Irish case.”


Imposing a loan-to-deposit target for Spanish lenders may mean they would have to reduce lending by 14 percent to 24 percent, Daragh Quinn and Duncan Farr, analysts Nomura International, wrote in a report published today. “The need to strengthen customer funding could also see the emergence of a deposit war, putting additional pressure on revenues, which are already likely to suffer from the low interest rate environment,” they said.”


(emphasis added)

Whoa, Nellie! Now that would certainly lead to a swift liquidation of unsound credit.

On deposit outflows and securitizations:


“Scrutiny of customer fund outflows at Spanish banks has intensified since the ECB said Aug. 28 that so-called private sector deposits shrank by 74 billion euros, or 4.7 percent, in July, the biggest drop on record. The ECB data include items such as deposits by securitization funds that banks say they don’t rely on for financing their business.

Banco Bilbao Vizcaya Argentaria SA (BBVA) said in a Sept. 4 report that a decline in securitization funds deposits helped explain the drop as banks substituted them by issuing covered bonds to discount at the ECB. Household and company deposits are stable once the practice of banks using instruments such as commercial paper to raise funds is taken into account. The loans-to-deposit ratio for BBVA’s Spanish business is 167 percent, according to the bank’s own data.


(emphasis added)

This essentially confirms what we said last month, but note that little detail about ECB funding (more on that below) and BBVA's loan-to-deposits ratio. 167% isn't exactly the pinnacle of conservatism.

On declining term deposits:


There is “a clear underlying trend of accelerating deposit decline,” Nomura’s Quinn wrote in a Sept. 4 report. Term deposits by households fell 6.9 percent in July from a year earlier, while those of companies fell 24 percent, which “points to continued deposit declines in the future,” he said.


A 24% decline in corporate term deposits in one month is a lot of wood.

On the reliance of Spain's banks on ECB funding – now this is really quite interesting:


“About 86 percent of Bankinter SA (BKT)’s estimated 2013 profits derive from its ability to borrow cheaply from the ECB, the analysts said, with Banco Popular Espanol SA dependent on central bank funds for about 79 percent of earnings. Meanwhile, Bank of Spain data shows lenders are offering higher deposit rates to attract cash, with interest rates on account for as long as one year climbing to 2.5 percent in July, the highest level since March.

Declining deposits may inflict more damage on the Spanish economy if the seepage of the most reliable source of funding further dries up credit, said Maughan at Olivetree. The International Monetary Fund predicts Spain’s economy will contract 1.7 percent this year and 1.2 percent in 2013.

“If deposits are falling, then the only option for Spanish banks to bring down their loans to deposit ratio is to cut back on the loans side,” Maughan said.


(emphasis added)

If 86% of a bank's profits depend on 'borrowing cheaply from the ECB', then it obviously means that these banks are not only held aloft by the central bank's ability to conjure up money from thin air, but they also enjoy a sizable subsidy. Obviously no subsidy comes for 'free' – it only appears that way when a central bank is providing it. In the end, all users of the euro are paying for the subsidized profits of banks in Spain and elsewhere in the euro area.



Spain's 10 year government bond yield, weekly candlestick chart. Yields have begun to tick up again as the 'complications' attending Spain's banking and economic woes take center stage again.



Germany's Biggest Bank – An Accident Waiting to Happen?

There was also an interesting article on Bloomberg about Deutsche Bank, Europe's biggest bank, which holds assets worth 80% of Germany's GDP.

“Will Germans Pick Up the Tab for Deutsche Bank, Too?”

The entire article is worth reading, but here is an especially noteworthy paragraph:


Its official capital ratios might seem respectable to a casual observer: At the end of the second quarter, it reported a core Tier 1 capital ratio (a regulatory measure of equity) of 10.2 percent of total assets.

The problem with this measure is that it uses risk-weighted assets. In other words, if a bank can convince itself and its regulators that it can apply lower risk weights to a given portfolio, its capital ratio will look higher.

What is considered to be a low-risk asset in the context of European banks? Typically, the sovereign debt of euro-area countries has been regarded as very low risk. But Draghi is being forced into extraordinary measures and the German constitutional court is being asked to rule on the ESM and other bailout measures precisely because sovereign debt for some euro countries has become so risky. And if you think there is a non – zero probability of the euro area breaking up, then risk-free assets have become a meaningless concept in Europe.

To evaluate any global bank today, it is much more advisable to look at its leverage ratio, the total size of its balance sheet relative to its equity, without any risk adjustments.

At the end of the second quarter, Deutsche Bank had total assets of 2.241 trillion euros ($2.93 trillion). Its total shareholder equity capital was 55.75 billion euros — a little less than 2.5 percent of total assets. That is a lot of leverage. Bloomberg News reported that this is the least equity (and most leverage) “among the 24 biggest European banks.”


(emphasis added)

Run that by us again? A bank holding € 2.25 trillion in assets has less than 2.5% of that figure in capital? Yes, you could say that is a lot of leverage. It's a good sight bigger than Lehman's was on the eve of its collapse. Obviously, not a whole lot must go wrong here, since a decline of more than 2.5% in the value of the bank's assets would evidently wipe its entire capital out.

How convenient that it can all be blown up to far more respectable figures via 'risk weighting' for regulatory purposes. And as the author of the Bloomberg article correctly states, it seems obvious that Germany will attempt to bail this bank out should it ever get into serious trouble.

Of course we all know that nothing can possibly go wrong, right?





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You may have noticed that our header carries ab black flag. This is due to the recent passing of the main author of the Acting Man blog, Heinz Blasnik, under his nom de plume 'Pater Tenebrarum'. We want to thank you for following his blog for meanwhile 11 years and refer you to the 'Acting Man Classics' on the sidebar to get an introduction to his way of seeing economics. In the future, we will keep the blog running with regular uptates from our well known Co-Authors. For that, some financial help would be greatly appreciated. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.


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