Deleveraging in the Eurozone

Vincent O’Sullivan and I have some thoughts on the issue for VoxEU here.

By Stephen Kinsella

Senior Lecturer in Economics at the University of Limerick.

19 replies on “Deleveraging in the Eurozone”

I’ve a couple of question: Re

In the aggregate, European banks need to raise €114.7 billion as an exceptional, temporary capital buffer against sovereign debt exposures and to ensure their individual Core Tier 1 capital ratio reaches 9% of risk-weighted assets by the end of June 2012.

Question 1: Does Basil 111 conformance require greater conformance than 9% mentioned above?


So far, most assets have been sold at close to market value, and it seems unlikely that banks (or indeed, governments) will let assets go at any price in an effort to raise capital in the short run.

This stand-off raises the probability of public bailouts in 2012 for a number of weaker Eurozone banks in particular, as they face a number of other challenges in raising capital through private sources.

First, management may hesitate to raise capital through a rights issue given the depressed nature of their stock— the average European bank’s equity is trading at only about 60% of its book value.

Question 2: I’ve a handle on Tier 1 capital ratios. Re stress testing, do the tools/methods for analysing conformity to above Tier 1 ratios ensure no possibility of Bed and breakfasting of assets between banks.

Question 3: With regard to assets of a bank holding derivatives it has purchased in the shadow banking sector, how are such assets weighed or measured to insure they can be adequately monetised in terms of an asset or a liability for that banks.

A very good read.


“Public sentiment has turned against government bailouts in the past two years, and as a result politicians may be more inclined to let institutions fail, rather than shoring them up with public money, than they were a couple years ago.”

But what happens when they fail? Still no EU bank resolution programme as far as I know.

As of 10th November the position was, according to Commission sources, in response to an email I sent:

“The legislative proposal you refer to is being finalised. We expect
that the Commission will formally adopt it before the end of the year.”

I shall send them an eChristmasCard and see where this stands.

@Gavin / Stephen

Good point. Your quote from the article also caught my attention.

My understanding was that banks were no longer allowed to fail!!
Indeed, from the point of view of a paying sovereign, I suspect that it would be cheaper to recapitalise a bust bank than to let close it as in the case of Anglo/INBS.

If Stephen means that politicians would be more inclined to let banks fail and simply not pay selected creditors (bondholders) then roll on the day, even if the legislative basis (resolution) was still unresolved.

And good luck with your Christmas post. If Kevin Cardiff’s new salary is anything to go by these people must work Christmas Day and all.
Check your email after you have had the plum pudding.

This week, a survey by the Irish Small and Medium Enterprises association (Isme) revealed that more than half of the Irish SMEs that applied for bank funding in the past three months were refused. More than a third saw their bank charges increase, and nearly a quarter faced higher interest rates. The findings concurred with an ECB survey on access to finance in the euro area, which found that SMEs in Ireland were second only to those in Greece at being refused bank loans

Please explains what these ‘percentages’ mean (to a non-financial person).

Swedbank Ab started at “228”.

Is that an LtD of 288% ie. 1:2.88 (seems unrealistically healthy)

or is it

an LtD of 0.34% (seems unrealistically unhealthy)

or is it something else?

Please explain.

it means they have deposits of 100 but have given out loans of 228. so if the bank is capitalized at 22 (more or less 10%) and 15% of loans default, then deposits are destroyed. it also means that the bank likely has massive maturity mismatches. it has to borrow from other banks to fund almost every withdrawal because all the money has been loaned out. and a deposit run is devastating for that bank.

these numbers are so horrible – it seems there is little or no choice but to let some of them go, but swedens banks seem massively leveraged so how do they manage?

I have this knawing feeling, that unless a sovereign lives at, or slightly under its means, that eventually, in the long run, like now, (we’ve had 40 years at it), things get a tad tricky on the fiscal front.

Would someone like to opine or model, what would be the outcome if Irl Inc spent exactly what it took in in income. That is, there was a constitutional prohibition on borrowing for day-to-day spending, and we could get interest free loans from ECB to build-out strategic infrastructure.

I am assuming annual G*P is at 1995 level (I know this is optimistic) and never increases (but will decrease). I have formed the opinion (careful analysis of future energy difficulties) that this situation may become the new norm in western, developed economies, apart from the odd Dead-Cat bounce, that is.


and the worst banks appear to be scandinavian (sweden, Denmark, Norway) followed by italian banks and then German ones. So lrts see how the countries that are not in th euro zone but have massively leveraged banks anyway, can get through this.

So if The Scandanivia banks are so massively over-leveraged, why is there no corncern about them, rather than Commerzbank (123) and Credit Agricole (82) ?

@Stephen Kinsella
from the article

the average European bank’s equity is trading at only about 60% of its book value.

Extraordinary. A truly risible performance by the ECB and others entrusted with the management of a European Banking system.
The market is saying your assets are worth 60% of what you say they are worth.

I think the EBA will back down on the deleveraging requirements. They are totally pro cyclical and make no sense the worse things get.

i suspect the scandinavians are not a central concern because the narrative, that the ECB can solve everything by printing, doesn’t apply to Scandinavia. similarly the UK banks can go under without causing a systemic problem for the Euro. Germany is a different case. The French banks are a concern because they were very involved in derivarives (off balance sheet of course).

@ Bklyn_rntr/Ollie

the Scandi housing/mortgage market is incredibly stable due to the popularity of specialised mortgage lenders and covered bond issuance. The LTD level isn’t as much of a problem because there’s an awful lot of matched funding going on, and the headline numbers overstate the true position. Swedbank is a bit different cos it does have some Baltic exposures, but Svenska Handelsbanken is probably about as safe a bank as you can find in Europe these days.

@Michael Hennigan
re The ECB is now to blame for stockmarket performance? ?

The ECB website is linked to below

Take a note of the ECB’s self declared tasks financial stability and supervision.

Drill down further into the definitions provided by the above and take a note of what the ECB view as typical risks and lines of defence.

Now to answer your question.

How can an institution that purports to have the responsibilities it outlines for itself (with the cooperation of other authorities) claim anything other than sheer incompetence in the carrying out of those responsibilities by virtue of the fact that nobody especially the markets believe the European Banking system is stable or secure. So much so that the markets believe that the book value of bank assets is overstated by 66%.

The ECB is not to blame for market performance but the ECB is to blame for the state of the European bank balance sheets that underlie that stock market valuation.


A simple solution to all this:

Until economies recover allow banks to hold core Tier 1 ratios at 2% to 4%. As economies recover insist banks bring their core tier 1 ratios to over 9% very quickly otherwise they lose their licences.

Whats wrong with this simple but althogether more logical approach.

@ YoB

are you going to put a deposit in, or buy a bond from, a bank with a bank with a 2-4% CT1 ratio?


Why not – we did it by the truck load between 2000 and 2007.

My point being that following the losses that are sitting in the loan books of the banks being properly written off it allows banks in a depression room to make a lending error. At the moment they can neither afford to lend nor afford to make a mistake in any lending decision. This is massively destructive to the wider economy.

I don’t pretend to know the full extent of the losses that are requried to be taken but it makes no sense that having taken these losses the Regulator would insist as he continues to do that the Tier 1s should be restored to 10.5% following this course of action. One cannot expect to rebuild Rome in a day. The Regulator needs to take he head out of his Basel III rule book and look at the effect his strangulation policy is having on the wider economy. Its not working. I’ve repeatedly stated on this site that we need to do some very simple things to restore the bases of an economy:

Declare RoI a Basel III free zone for the next 5 years

Reduce DIRT to nil and give some incentive for deposit holders to return their cash to the country.

An across the board mortgage write down for ALL mortgages originated from 2001 to 2008 using a 7% net rental yield as a basis for house price valuations at the date of origination. Pass the write bill to the unguaranteed bond holders and the balance to the ECB.

What were attempting to do here is extend and pretend and it is failing in virtually all aspects. Fixes are or were never designed to be fair – the fairness to all mindset is wooly headed expectation that will deliver us to a road to ruin. We already on said road and hence the reason many are taking side roads to the bankruptcy courts in the UK. The direction needs to change.

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