Europe’s interbank stress

Another decent night on European equities as German employment and the world-wide manufacturing data gives some hope that 2012 will be a year of economic recovery and the world is moving beyond the stagnation of 2011.  It is far too early to make such a call in my opinion as I am not yet convinced of the “European de-coupling” meme. That is not to say I expect Europe to drag the rest of the world into depression, it is just that my base case for Europe appears to be more bearish that what I am seeing reflected in the equity markets at this point and, as always, the fundamental issues within Europe remain in place and, in most part, unregulated.

Outperforming German data is something I have spoken about previously and last night’s record German employment data once again highlighted this point. This data was celebrated by equity markets as, rightly for Germany, it is a good news but the economic output gap between the strong and weak European nations is a major source of the continent’s issues and this data is again a double- edged sword.

We also saw some good news from other markets with both Belgium and The Netherlands selling short term debt at lower yields than previous auctions.Neither of these nations was having any trouble with these auctions, so this isn’t game changing, but it does show that the 3 year LTRO is having an effect on the short term sovereign debt markets which is good news for some of the other nations that are under far more pressure.

As I explained yesterday, the longer-term markets are a different kettle of fish and the ECB is still having to provide support for those markets via the SMP, much to the dislike of a number of board members. Although the LTRO does seem to have done some good for short term sovereign debt via supporting direct purchases, or at least the perception of them, it doesn’t appear to be helping in the area that central bank operations actually target. That is, interbank market stability.

The latest ECB data shows that banks parked a near record 446bn Euro in the ECB’s deposit facility, but this in itself isn’t a problem. What is the problem is that the increasing use of the ECB’s marginal lending facility shows that not all of these parked reserves are actually “excess to market requirements”.

What appears to be occurring is that banks are hoarding reserves instead of providing them to the interbank market. If I took a guess I would suggest that this being caused by deposits flowing out of periphery banks into the core (and probably some non-Euro markets). These flows require the periphery banks to recoup some of their lost reserves which they would normally do in the interbank market.

Given that the core banks would be well aware of the large deposit outflows, they seem unwilling to lend the additional reserves they would be receiving from these operations back to those periphery banks via the normal channels. This means that the periphery banks are being forced to use the more expensive marginal lending facility provided by the ECB to meet their reserve requirements. This is classic “credit crunch” behaviour.

Yesterday’s chart of the day gives us a hint where the stress is likely to be coming from.

The LTRO was obviously an attempt to alleviate this type of stress but it appears to be failing and this is a problem for the stability of the financial system. In addition, as I explained yesterday, this is not an environment supportive of private sector credit creation and therefore will be adding strain to the some bank’s balance sheets as deflation eats at their asset quality.

There is the possibility the recent sharp uplift in the use of the marginal lending facility is related to some form of end of year operations and may fade over the coming days. There has, however , been a growing trend in the use of the facility leading up to the 3-year LTRO so this is definitely something to keep your eye on over the next week.

The other big thing on my radar is the Greek PSI+ which appears to be reaching a conclusion… one way or another.

Greece will have to leave the euro zone if it fails to clinch a deal on a second, 130 billion euro bailout with its international lenders, a government spokesman said on Tuesday.

It was an unusually public stark warning from the embattled country, aimed at shoring up domestic support for tough measures and possibly also at the lenders themselves.

“The bailout agreement needs to be signed otherwise we will be out of the markets, out of the euro,” spokesman Pantelis Kapsis told Skai TV. “The situation will be much worse.”

Greece is racing against the clock to agree with the EU, the IMF and private bondholders on the details of the rescue plan before a major bond redemption in March. It risks a default if there is no deal by this date.

Given the amount of resources (economic and political) that have already been spent trying to keep Greece in the Euro I consider this talk little more than posturing. There have, however, already been reports in the Greek media suggesting that a PSI+ deal will be at a greater level than 50%. It is yet to be seen if this is the case because there are a number of groups of creditors who seem unlikely to support the action and we also already know that 50% isn’t really half.

If this does turn out to be the case then this is obviously a good outcome for Greece but would require the banks to take on greater losses. This is not something that is going to be helpful in regards to banking stability at this point and is therefore likely to exacerbate the interbank issues.

Comments

  1. DE,

    Do you know if the current refinancing of the debt rollovers involves taking a haircut for the existing investors? I am not sure but I read (seems sooo long ago) that nothing decisive had been reached in terms of haircut (wether it was a PV hit or a writedown in face value)

    Could you provide a link that sheds some more info on this?

    Ta