Europe heading into recession
Discussion
fblm said:
^ Well explained. (As an aside, am I right in assuming the equity return acceptable to a US bank is considerably higher than EU making the relative balance sheet cost even wider than your example?)
Yep return on capital employed in US banks is about double of EU banks.Simply, they f
ked it.Edited by stongle on Tuesday 5th November 16:46
Just found another Mark Blythe lecture. It's from 2015 which I find to be interesting as he seemed to have called it right back then (i.e. before brexit).
Kicks of properly around 12:51.
https://www.youtube.com/watch?v=B6vV8_uQmxs
Kicks of properly around 12:51.
https://www.youtube.com/watch?v=B6vV8_uQmxs
stongle said:
Here's a very simplistic (and for forum brevity) example of how one of the BASEL rules - Supplemental Leverage Ratio, was uneven:
In Europe, there is a 3% floor on capital for leverage ratio; in US banks it's closer to 7%. This means, for every $1bn of balance sheet (or loans the bank has made - in whatever form); you need to hold $30m in Capital in a Euro bank or $70m in a US bank (capital is your loss absorption buffer). if you have a 12.5% equity cost (or hurdle rate) - it costs a European bank $3.75m to run a $1bn of balance sheet, US bank $8.75m. US banks will look to offload their balance sheets into European banks - but retain the performance of their investments. There are various mechanisms for this; but what happens is US banks pay more for European bank balance sheet than the EU banks can get locally or by lending EUR in the zone...
I won't even pretend to have more than a surafce understanding of what you are talking about here, but does this mechanism of US banks utilising more favourable EUR banking conditions expose them to a significant counterparty risk in the event of the EUR banks getting into trouble?In Europe, there is a 3% floor on capital for leverage ratio; in US banks it's closer to 7%. This means, for every $1bn of balance sheet (or loans the bank has made - in whatever form); you need to hold $30m in Capital in a Euro bank or $70m in a US bank (capital is your loss absorption buffer). if you have a 12.5% equity cost (or hurdle rate) - it costs a European bank $3.75m to run a $1bn of balance sheet, US bank $8.75m. US banks will look to offload their balance sheets into European banks - but retain the performance of their investments. There are various mechanisms for this; but what happens is US banks pay more for European bank balance sheet than the EU banks can get locally or by lending EUR in the zone...
egomeister said:
I won't even pretend to have more than a surafce understanding of what you are talking about here, but does this mechanism of US banks utilising more favourable EUR banking conditions expose them to a significant counterparty risk in the event of the EUR banks getting into trouble?
All trades are generally collateralised. There is virtually no unsecured lending between banks today. If anything the EU banks probably have more credit risk. It would be a credit risk if you are long bonds / equity of European banks - but you tend to avoid correlated trades (lend money to bank A take bank A shares as collateral). Its not profitable and consumes too much capital.Of course there is some risk, but daily margining of collateral / and if possible adequate haircuts are put in place. You can never be fully protected, but this is what you hold capital for.
It becomes a problem IF velocity overtakes events, or markets go into freefall devaluing collateral faster than you can margin call (or banks have the ability to raise margin payments).
This is a big issue as the system is built on leverage and collateral re-use between banks. Risk magazine ran an article where they assesed the impact of the BREXIT vote on market volatility and intraday margin calls. On the Friday in 2016, LCH (Lkndon Clearing house) called an additional GBP14bn of intra day margin collateral. If certain Italian banks were held to the same prudential standards they would not have held sufficient capital to cover (or borrow to cover) your margin call; hence would be placed into default. If banks start to topple, the wholesale funding market they are dependent uppn freezes up, so even if you are solvent its difficult to borrow.
If one bank goes under, you are in a race to liquidate collateral before the market goes into freefall. If its a big enough default everyone runs for the exit at the sametime. This is what happened in the aftermath of Lehman. The problem is worse today, given proliferation of algo trading systems / bots. They may exacerbate a sell off, ramp up the velocity.
Given its a hugely complicated and interlinked system, contagion is deeply feared. Last month, the US Repo market turned hugely illiquid and due to a shortage of $ in the system (Tax payments and UST issuance to be paid for); the lending rates skyrocketed. To stop the market shutting down; the Fed pumped over $350bn of additional cash into the system.
If you built a balance sheet based on leverage, but your collateral / securities you used to built it have become less valuable; you won't be able to keep up with the margin calls SO avoiding Firesales is critical to regulator thinking. Guess where they have an issue pulling exchange circuit breakers / slowing firesales...
Edit to add, I think I explained leverage / balance sheet building a few pages ago. It might be worth a scoot back a bit. I'm sure there was a simple example.
EDIT EDIT, I did, on the 18th Sept.
Edited by stongle on Tuesday 5th November 21:54
Edited by stongle on Wednesday 6th November 08:42
stongle said:
egomeister said:
I won't even pretend to have more than a surafce understanding of what you are talking about here, but does this mechanism of US banks utilising more favourable EUR banking conditions expose them to a significant counterparty risk in the event of the EUR banks getting into trouble?
All trades are generally collateralised. There is virtually no unsecured lending between banks today. If anything the EU banks probably have more credit risk. It would be a credit risk if you are long bonds / equity of European banks - but you tend to avoid correlated trades (lend money to bank A take bank A shares as collateral). Its not profitable and consumes too much capital.Of course there is some risk, but daily margining of collateral / and if possible adequate haircuts are put in place. You can never be fully protected, but this is what you hold capital for.
It becomes a problem IF velocity overtakes events, or markets go into freefall devaluing collateral faster than you can margin call (or banks have the ability to raise margin payments).
This is a big issue as the system is built on leverage and collateral re-use between banks. Risk magazine ran an article where they assesed the impact of the BREXIT vote on market volatility and intraday margin calls. On the Friday in 2016, LCH (Lkndon Clearing house) called an additional GBP14bn of intra day margin collateral. If certain Italian banks were held to the same prudential standards they would not have held sufficient capital to cover (or borrow to cover) your margin call; hence would be placed into default. If banks start to topple, the wholesale funding market they are dependent uppn freezes up, so even if you are solvent its difficult to borrow.
If one bank goes under, you are in a race to liquidate collateral before the market goes into freefall. If its a big enough default everyone runs for the exit at the sametime. This is what happened in the aftermath of Lehman. The problem is worse today, given proliferation of algo trading systems / bots. They may exacerbate a sell off, ramp up the velocity.
Given its a hugely complicated and interlinked system, contagion is deeply feared. Last month, the US Repo market turned hugely illiquid and due to a shortage of $ in the system (Tax payments and UST issuance to be paid for); the lending rates skyrocketed. To stop the market shutting down; the Fed pumped over $350bn of additional cash into the system.
If you built a balance sheet based on leverage, but your collateral / securities you used to built it have become less valuable; you won't be able to keep up with the margin calls SO avoiding Firesales is critical to regulator thinking. Guess where they have an issue pulling exchange circuit breakers / slowing firesales...
Edit to add, I think I explained leverage / balance sheet building a few pages ago. It might be worth a scoot back a bit. I'm sure there was a simple example.
Edited by stongle on Tuesday 5th November 21:54
fblm said:
To be fair that ZH article is really crap even by ZH standards.
I tend to avoid ZeroHedge, I'm bearish as it is; I'd be unable to sleep. Some howlers in there though. Equating exposure to derivative notional outstanding, hmmmmmmm.IF Deutsche hit the skids, most of that notional collapses in on itself. No one runs a market or credit risk delta of that size; not even the ECB
The remaining shockwave should be contained by:
- Default fund mechanism at Central Clearing Houses
- Collateral liquidation
- Regulator action
The later 2 are going to be unpleasant for everyone.
Unrelated to Deutsche's notional, few people believe other European banks can absorb a shock of DB going down (after the above), as their capital / loss absorption buffers are too small. The minute the market thinks DB is in the s
t, anyone whom looks highly exposed or correlated losses there ability to fund (or has risk premia adjusted into orbit).The domino effect IS a risk, but it comes on a different vector. Remember, none of this post crisis regulation has ever been fully tested. And thats before the banks gamed it.
You can tell that, deep in the core of the EU, there is a hatred of FS. Just look at how regularly they have gunned for the City and also the Swiss. The reaction to the GFC has been to rip the teeth out of the Eurozone banks, hence why ZIRP and then NIRP has simply not translated into the real economy.
Digga said:
You can tell that, deep in the core of the EU, there is a hatred of FS. Just look at how regularly they have gunned for the City and also the Swiss. The reaction to the GFC has been to rip the teeth out of the Eurozone banks, hence why ZIRP and then NIRP has simply not translated into the real economy.
Coincidently, today MAY be interesting for that. Seems Scholz is due to make a statement later today; on unblocking the deadlock on the EU’s planned Banking Union.Cross border banking / integration / mergers have never really worked well; as the German’s and Dutch didn’t want to pay into a Euro wide depositor protection scheme (not even European, but EUROZONE unity at its best). Evidently, Germany MAY now be willing to pay into this fund “IF” certain caveats are met.
The caveats are largely predictable, or even humorous. If Germany etc underpins a default fund; everyone has to set aside capital for holdings of Sovereign debt. Italian banks have a combined exposure of around EUR700bn to the Italian government (grown exponentially since 2008), of which they take no capital provision for… Zero. Not only zero credit risk protection in event of a default (which given public sector debt balloon / debt to GDP ratio etc shouldn’t be ignored); but nothing against market risk or daily price fluctuations.
The German’s are saying; if you want our support; become more prudent or de-risk yourselves. It certainly isn’t a vote of confidence in their neighbours. Obviously upping capital provision is something of a problem for Italian banks. Either get more of it (expensive further hitting NIM); stop making stupid loans or deleverage (ooops, Monetary policy requires it).
One side will have to give. The European’s need banking consolidation; it’s hampering monetary transmission AND they need to re-risk the sector. Banking union is also more critical (read protectionist), as they could end up in a situation where UK, US and RoW banks end up picking over the carcass of what’s left over.
ON a happier note, German manufacturing orders increased 1.3% end of Sept (but down 5.4% on last year).
Bloomberg said:
The IMF warned Europe to prepare emergency plans for an economic slump, as risks to the region's outlook spread and monetary policy had all but exhausted its arsenal.
https://www.bloomberg.com/news/articles/2019-11-06/europe-warned-to-prepare-for-the-worst-as-imf-sees-clouds-darken?srnd=premium-europeManagement Summary: Bloomberg has been copying NP&E's homework.
stongle said:
I tend to avoid ZeroHedge, I'm bearish as it is; I'd be unable to sleep. Some howlers in there though. Equating exposure to derivative notional outstanding, hmmmmmmm.
...
Not for the first time. ZH loves to get all excited about notional gross derivatives 'exposures', especially DB's. Look big scary number! How can they possibly pay it all back? Run for the bunkers!...
European Commission released their latest forcasts this morning:
Growth through to 2021 -- 1.2% Inflation 1.3% (ouchies on the inflation figure)
They also say; all countries need to spend more.... Germany says "nein, ze situation is ztable".....
BOE also out today:
Easing on the agenda.
They see a transition to a deep and meaningful FTA (if only - parliament may fk that up).
Growth to 2021 1.8% 3 year inflation outlook 2.25% (so helpful to erode debt). 2020 growth @ 1.2% in line with EU.
Increasingly talking about an outlook outside just BREXIT and EU.
Growth through to 2021 -- 1.2% Inflation 1.3% (ouchies on the inflation figure)
They also say; all countries need to spend more.... Germany says "nein, ze situation is ztable".....
BOE also out today:
Easing on the agenda.
They see a transition to a deep and meaningful FTA (if only - parliament may f
k that up).Growth to 2021 1.8% 3 year inflation outlook 2.25% (so helpful to erode debt). 2020 growth @ 1.2% in line with EU.
Increasingly talking about an outlook outside just BREXIT and EU.
Edited by stongle on Thursday 7th November 12:16
Vanden Saab said:
CzechItOut said:
When does the UK release the Q3 GDP growth figures?
prelim figures on the 11th...https://ec.europa.eu/eurostat/tgm/table.do?tab=tab...
any predictions?
or thread followers, ECB published it's semi annual Financial Stability Review:
https://www.ecb.europa.eu/pub/financial-stability/...
Could've cut and paste this thread
Quick takeaways:
They expect gowth to be lower for longer
Increase of contraction by mid-2020; up an additional 20%
70% of bonds held by insurers and pension funds now yield <1%
Low yield environment leading to excessive risk taking in bank and non-bank sectors - increased liklihood of a coming correction
Debt sustainability in a low growth environment is a concern
Asset mispricing
https://www.ecb.europa.eu/pub/financial-stability/...
Could've cut and paste this thread
Quick takeaways:
They expect gowth to be lower for longer
Increase of contraction by mid-2020; up an additional 20%
70% of bonds held by insurers and pension funds now yield <1%
Low yield environment leading to excessive risk taking in bank and non-bank sectors - increased liklihood of a coming correction
Debt sustainability in a low growth environment is a concern
Asset mispricing
As an anecdotal aside, I will be extremely interested to see the UK 2019 q4 figures once they are released. My intuitive guess is that:
Furthermore, only #2 of the above has any definitive point of resolution and, even then, unless it is a clear Tory win, is by no means the end of that uncertainty.
- Weather
- Election
- Continued Brexit uncertainty
Furthermore, only #2 of the above has any definitive point of resolution and, even then, unless it is a clear Tory win, is by no means the end of that uncertainty.
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