How stressed are Europe's banks?

Pretty soon, the European Central Bank will be down to taking busted printers and leftover paint as loan collateral.

By Jim J. Jubak Jun 22, 2012 3:59PM
Image: Euro (© Corbis)Watch what they do and not what they say, if you want to track the trend in the euro debt crisis.

Friday morning's headlines from Rome, where the leaders of Germany, France, Italy, and Spain have just completed a mini-summit in advance of next week's full European summit, are full of calls to action.

"There was an agreement between all of us to use any necessary mechanism to obtain financial stability in the eurozone," Spanish Prime Minister Mariano Rajoy said in the post-meeting press conference.

"I absolutely agree with what everyone else here has said -- to devote 1% of the GDP of the European area additionally to growth, to efficiency in growth and to investment. That is a genuine signal that we need,” said Germany Chancellor Angela Merkel. (That 1% of GDP amounts to about 130 billion euros, or $164 billion.)

Sounds like we might be on an upward track, right?

Well, in the world of actions and not words, Friday the European Central Bank agreed to accept lower-rated asset-backed securities as collateral for loans to European banks. Asset-backed securities, including those backed by commercial mortgages, auto loans, and consumer finance loans, will now be eligible as collateral as long as they are rated at least BBB. In the Standard & Poor's credit ratings system BBB is one grade above BBB-, the lowest investment-grade rating, and just two grades above a speculative rating of BB+. The central bank will apply a haircut to these lower-rated credits so, for example, $100 in BBB-rated asset-backed securities could serve as collateral for just $84 in bank borrowing. But make no mistake about it, Friday’s action is a major expansion of the kinds of collateral that the central bank will accept.

Why is this important?

The European Central Bank wouldn't be expanding the list of collateral that it accepts from banks if some banks weren't having trouble finding funding for their operations. My read is that some banks, even after the central bank’s huge provision of cash through its December and February three-year loan facility, are having trouble funding their operations because they don’t have enough collateral under the former rules to use to secure central bank loans. 

Easing the standards for collateral addresses this problem -- and is a sign of exactly how stressed some banks in Europe are. (Once upon a time, when Jimmy Stewart ran the Bailey Building and Loan, banks raised the money they lent out from depositors. Nowadays, some funding for loans still comes from depositors, but until this crisis it increasingly came from the short-term capital markets where banks borrow the money they lend. These markets have been closed to many banks by the global financial crisis and the euro debt crisis. And that has left banks scrambling for new sources of funding -- and for new funding sources that will let them roll over their short-term money as it comes due. It has also led some banks to rediscover the value of deposits from savers.)

A source of that stress is the continued reluctance of U.S. money market funds to provide short-term funding for European banks. According to data from Fitch Ratings money market funds are allocating about 12% of their assets to eurozone banks in 2012. That’s down from roughly twice that allocation a year ago. Before the crisis, many European (and other) banks had come to rely on cash from money market funds to fund their operations. That money is now in short supply and although eurozone banks have all said that they have moved away from this source of funding, it’s a good bet that not all of them have made the shift.

Hence the need for the European Central Bank’s move on collateral today.

It’s hard to tell exactly where the most stress is in the eurozone banking system. But I’d look to France, where the banks were especially dependent on short-term funding from the capital markets. And I'd look to smaller banks certainly in Italy and Spain, but also in Germany. It is interesting -- maybe "revealing" is a better word -- that Germany is all in favor of more regulation by a central banking authority as long as that regulation covers only the country’s biggest banks. Germany starts to balk, however, when the proposal starts to include centralized eurozone regulation of the country’s smaller banks.

At the time of this writing, Jim Jubak didn't own shares of any companies mentioned in this post in personal portfolios. The mutual fund he manages, Jubak Global Equity Fund (JUBAX), may or may not own positions in any stock mentioned. The fund did own shares of Banco Santander and U.S. Bancorp as of the end of March. For a full list of the stocks in the fund as of the end of the most recent quarter, see the fund's portfolio here
8Comments
Jun 27, 2012 6:57AM
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Jun 23, 2012 6:21PM
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Stressed? Yes, it must be stressful to be insolvent, especially if you're a bank. "Insolvent" means you have negative net worth, after debts are considered. All this ECB wrangling is only addressing the LIQUIDITY issues of the Euro banks. The fundamental insolvency is going unaddressed--perhaps with the idea that given enough time all those bad loans will pay off. As it stands, every time the interest rates ratchet up for Spanish and Italian sovereign debt, and the bond values go down, the equity at Euro banks diminishes. Even after 2008, the regulators in Europe were telling the banks that they could count all Euro sovereign debt as AAA and full-price on their balance sheets, regardless of the country floating the bonds. So of course they loaded up on higher-paying sovereigns. Now they have the same problem US banks had in 2008, when so-called AAA mortgage derivatives--made up of low-grade underlying debt--had to be re-priced to what they were really worth. Except for the German banks--and I'd be skeptical about them too--I doubt there are very many truly solvent banks left in the Euro-zone.
Jun 22, 2012 11:06PM
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Wait!  Let's privatize all that Social Security money!  Ah . . . yeah.  Except there is no Social Security money.  I have my Social Security deducted from my pay.  It is immediately transferred to my Mom in Phoenix, Arizona.  Her Social Security benefit.

 

Oh well, seemed like a good idea at the time.

 

Okay, wait.  How about we get Octomom and Sandusky dancing in g-strings in some topless bar in Bristol, Tennesse.  That should make a few bucks, right?

 

Ah well.  It's late, I'm tired, I'm going to bed.

 

 

Jun 22, 2012 8:49PM
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History is just going to repeat itself with our recession. The rich will get off scot-free and the middle class and poor will foot the bill. The rich greedy people that own the Republican party will see to that. Pony up your hard earned money.
Jun 22, 2012 7:50PM
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There has to be somebody who is tracking the flow of European investment money into U.S. markets and U.S. companies.  It must be a lot.

 

 

Jun 22, 2012 7:33PM
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This whole mess has been one big joke to investors in stocks!! Basically it was a crime seen brought on by Wall Street!!!
Jun 22, 2012 5:37PM
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Socialism has only one end, bankruptcy!!! The way out of this economic mess is a major restructuring of the American economy. However, before we will do that we are going have get hit in the head with an economic 2x4, and 2x4 is coming.
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