The Sociopathic Banking System of Europe

In spite of the recently conducted stress test of European banks, concluding that most of them have enough core capital to weather a “worst case scenario,” we now learn that they will need at least EUR 200 billion more to be on the safe side – and probably more. Here at the EconoTwist’s we’re not the only ones who think this is getting way out of hands: It seems like no one is really sure of the banks real risk exposure, not even the banks themselves, the stress test have once again proved to be a joke, and who the Hell do they think they are? – the IMF and the banking associations who think they just can demand the euro zone governments to fill up their bottomless buckets?

“This is the second time it has happened.”

Elena Salgado

Yesterday, the IMF leaked its calculations of required capital for a recapitalization of the banks in the euro zone, well ahead of the publication of IMF’s financial stability report later this month. This amount is now EUR 200 billion. And of course it has triggered a debate within the euro zone. But the discussion is also rather skewed: the main issue is the actual number, 200? 300? Who cares? The real problem is that we still don’t know the health of our financial system – three years after the crisis hit!

The staff at the International Monetary Fund have triggered another fierce dispute with euro zone authorities over their estimates, showing even more cracks in the European banks’ balance sheets, related to their holdings of troubled euro zone sovereign debt.

Christine Lagarde

(Yeah, another quarrel – just what we need….)

The analysis, which was discussed by the IMF’s executive board in Washington on Wednesday, are strongly rebutted by the European Central Bank and the euro zone governments, which say it is partial and misleading.

Is there anybody trustworthy, these days?

According the Financial Times, the IMF’s analysis, currently in a drafted version of its regular Global Financial Stability Report (GFSR), uses credit default swap prices to estimate the market value of government bonds of the three euro zone countries receiving bailout money from the IMF – Ireland, Greece and Portugal – in addition to the bonds of Italy, Spain and Belgium.

Although the IMF analysis may be revised, two officials says one estimate show that marking sovereign bonds to market would reduce European banks’ tangible common equity – the core measure of their capital base – by about EUR 200 billion (USD 287 billion), a drop of 10-12 per cent.

The impact could be increased substantially, perhaps doubled, by the knock-on effects of European banks holding assets in other banks, Financial Times writes.

In other words: the IMF estimates are just as worthless as the stress tests – the only thing that is certain is that most banks will need more substantial capital injections if they are going to survive.

Anyway – the ECB and the euro zone governments strongly rejects these estimates.

Elena_Salgado

Spanish finance minister, Elena Salgado, told the Financial Times yesterday that the fund makes a mistake by looking only at potential losses without also taking account of holdings of German Bunds, which have risen in price.

“The IMF vision is biased,” she said. “They only see the bad part of the debate.”

Now, that’s another “truth with modifications,” because the gains in Bunds are comparatively small in relation to the losses on other sovereign bonds.

“This is the second time it has happened,” the Spanish finance minister points out, referring to the fund’s October 2009 GFSR, which estimated that euro zone banks had only written down USD 347 billion of USD 814 billion of probable losses from the financial crisis. IMF later revised down that total of probable total losses.

Well, I’m afraid it will not be the last time, either…

Mrs. Salgado goes on saying that the European stress tests of banks is a better indication of their vulnerabilities.

Now, that’s just plain wrong!

The stress tests do not only lack credibility, they also assume no losses on sovereign debt holdings in the bank’s books.

As www.eurointelligence.com rightfully underlines, it is very likely that investors in Greek and peripheral debt securities will ultimately face losses, especially given the European Council has already agreed to accept a degree of private-sector participation.

Considering the decline in economic growth, now evident throughout the whole euro zone, those losses will increase substantially.

This means that the IMF estimate of an additional EUR 200 billion in bank aid most probably is overoptimistic underestimation.

But this line of argument is really a total derailing of what’s ought to be the real discussion:

In the view of the EconoTwist’s we’re looking at a 3-part problem.

First, the accounting system that has developed into a untransparet jungle of techniques, making it totally impossible for both regulators, analysts and policy makers to gain complete oversight of the bank’s real risk exposure.

This includes the off-balance sheet financing, that once upon a time was created as a special solution to fund important high-risk projects, but now being used for pure speculation – just as the traditional derivatives.

Then we have the cross-border activity. The fact that the financial industry have globalized faster than any other industry, and faster than national (local) authorities are able to handle, have created a situation where banks may speculate, taking advantage of different rules in different countries, taking on more risk with little or no need for reporting and disclosure.

To make things even more confusing, international regulators invoked a special set of rules in the aftermath of the Lehman collapse, allowing the banks to put whatever price tag they see adequate on the toxic, worthless assets they possess.

This is called a “mark-to-mark” principle.

However, new rules, now being implemented through the Basel III regulations requires that banks return to the old principle of “mark-to-market.” That means putting the actual market valuation of their assets on their balance sheet.

EU officials involved in the debate say the “mark-to-market” principle explains much of the recent fall in EU’s commercial banks’ share prices, including French and German institutions that have large holdings of euro zone sovereign debt.

“Marking to market is a fairly brutal exercise, but these are the estimates that hedge funds are currently making,” one official says to the FT, following criticisms of European banks made by the International Accounting Standards Board, which sets the common bank accounting rules, to the European Securities and Markets Authority, EU’s markets regulator.

And the third unresolved problem is called the “shadow banking system.”

Officials say the IMF staff do not claim their estimate is a comprehensive measure. But they say that the analysis strongly suggests European banks need to raise more capital, an argument recently made by Christine Lagarde, the fund’s new managing director.

No one disputes that fact.

The final report will be published in three weeks’ time just before the IMF’s annual meetings, and is subject to revision depending on the debate between fund staff and the fund’s executive board.

But these authorities and their officials can evaluate, calculate and estimate all they want:

Before the regulatory mess is cleaned up, things are not going to look any better and more nasty surprises can be expected.