Monday, September 12, 2011
I present some basic statistics to highlight the problem in Europe. In short, there exists a deleterious positive feedback loop between overly leveraged banks and their sovereigns in key markets.
Exhibit 1: European Banks are overly levered. Spanning 2006 through the latest data point, key European banking systems - France, Germany, and Italy - increased leverage.
The chart above illustrates the ratio of bank assets to capital (see the IMF's Financial Soundness Indicators for the data and description of 'capital'). The countries are ranked by largest % drop in bank leverage spanning the period 2006 to current (Greece, Austria, and Belgium) to the largest % surge in leverage spanning the same period (France, Italy, and the UK). Note: the 2006 data is taken from the 2007 IMF Global Financial Stability Report.
The level of leverage is not strictly comparable across countries due to differences in national accounting, taxation, and supervisory regimes. However, while the US banks have delevered over the period, the big European banks - Germany, Italy, and France - have increased leverage. Assets need to be written down.
Exhibit 2. While leverage is too high, asset quality is dropping. The banks are increasing exposure to government loans and securities relative to traditional loans.
The chart illustrates the nominal stock of loans held on the bank balance sheets of the Monetary Financial Institutions in Europe. The data are from the ECB. Loans to governments and holdings of government securities are increasing more swiftly than traditional lending.
Exhibit 3. The asset quality of that rising stock of loans to the government sector is deteriorating...quickly. Italian and Spanish 10yr bonds are 1.5% and 1.2% higher, respectively, since the beginning of 2010, while German 10-yr yields are 1.5% lower.
The chart illustrates the 10-yr bonds across the euro area bond markets. The latest data point (today around 12pm) is listed in the legend.
Bond investors are clearly differentiating between the riskier bonds - Spain, Portugal, and Belgium - from the 'core' - Germany, Netherlands, Austria, Finland, and yes, France. Whether or not bond markets are right to regard Finland or France as 'core' is a different matter entirely. But the point is clear: bond markets are in crisis mode, and there's a stark segmentation in yields across the region.
Cross border exposure dictates that some of these highly levered banking systems are exposed to the same government securities currently trading at distressed levels. A case in point is France with outsized exposure to Italy and Greece (see Table 9B). This is a helpful graphic by Thomson Reuters .