The Financial Services Club's Blog

Stressed? Don't worry. The French and Germans will sort it out ...

I will not spend much more time on this, but was irritated by the CEBS stress tests last week and so one more quick note.

The reason CEBS, the European Commission and European Central Bank gave for not including the scenario of a sovereign default in the stress tests is that they just don’t think it’s going to happen.

“It is not possible”, they said.

“Why”, we asked.

“Because it is just incredibly unlikely and, even if anything did start to fragment in the fissures of finance in Greece or Spain, we have the European Financial Stability Fund (EFSF) to solve it”, they replied.

Now that’s an interesting statement ... because it is also a fuddle.

The EFSF is a €440 billion fund designed to cover any sovereign debt crisis in Europe in the future.

Therefore, the concept of a bank being exposed to huge losses from Greece and Spain is no longer an issue.

That is the logic.

And it’s quite good.

But it’s already been shot to pieces.

Ken Wattret, a market analyst with BNP Paribas, performed a really interesting analysis of the EFSF and issued a note in July that provides a clear Q&A overview. The analysis is available through their website (large pdf, see page 10) and a public version was summarised nicely by Financial News.

Here’s my summary of Ken’s research note:

The EFSF is a limited liability company based in Luxembourg announced in May as a measure to “preserve financial stability in Europe”. Its CEO is Klaus Regling, a former senior German Finance Ministry official who worked on the preparations for EMU and who has also worked at the IMF.

The purpose of the EFSF, according to its terms of reference, is “to collect funds and provide loans in conjunction with the IMF to cover the financing needs of Eurozone member states in difficulty, subject to strict conditionality”.

According to the Framework Agreement, the EFSF will finance the provision of loans via the issuance of “bonds, notes, commercial paper, debt securities or other financing arrangements” which will be backed by unconditional and irrevocable guarantees from those member states which participate.

Only the member states of the Eurozone participate in the scheme, providing guarantees up to a total of €440bn on a pro-rata basis.

If a Eurozone member state seeks assistance from the EFSF, they must initially agree a Memorandum of Understanding (MoU) with the European Commission, in liaison with the IMF and the ECB. This MoU will set out the budgetary and economic policy conditions which the Eurozone member state must comply with in order to receive financial assistance.

The detailed terms and conditions would then be set out in a Loan Facility Agreement which is subject to the agreement of all the guarantors (i.e. those countries in the EFSF).

The EFSF will enter into force when five or more member states, comprising at least two-thirds of the total guarantees, have confirmed that they have concluded the necessary procedures under their national legislation. It will last for almost three years, with the guarantees applying to loans made on or before 30 June 2013.

Now then, what Mr. Wattret did next is the most intriguing part. He produced this chart (double click to see larger image):

Column C3 is the one that interests me, for it shows that Germany and France contribute almost half of all of the ECB’s capital for this scheme, whilst the PIIGS – Portugal, Italy, Ireland, Greece and Spain – contribute almost 35% of the scheme, with Italy and Spain representing 30%.

Greece does not contribute anything to the scheme at this time for obvious reasons.

So what the ECB are saying is that the $1 trillion exposure of European banks to the sovereign debt of just Greece and Spain, as discussed yesterday, can be covered by the €440 billion available in an emergency through this scheme.

But let’s take this a step further.

Spain gets into distress and has to leave the scheme.

That removes a further 12% of the scheme’s funding.

In fact, if Ken had continued his percentages and logic across columns C6 and C7, then the new figures look like this:

In other words, should Spain have issues, the burden on France and Germany increases by a further 7% of the fund – or an additional €7.5 billion to bring their number to a total of €250 billion between them.

This is what prompted me to ask at the end of the CEBS press conference: “so what you’re really saying is that you didn’t use the scenario of a sovereign default because you believe French and German citizens will be happy to bailout Spain like they did with Greece?”

That didn’t go down well but it had to be asked and, no matter how unlikely it is for this to occur, it is the reality of the situation.

Stress tests useful or misleading?

Having spent much of the weekend absorbing the European bank stress test results, I’ve got to ask why they bothered.

OK, so it was to get bank share prices up, but the whole thing was just a typical European sham where every country does things in a different way, with the whole thing designed to cover up the real weaknesses in the European banking system.

Bearing in mind that the stress tests were called to shore up confidence in the system due to the concerns in the markets over a sovereign default in Greece or Spain, the fact that the tests left out that particular scenario is ridiculous.

In case you didn’t catch it, the tests looked at a double dip recession and a sovereign debt shock, but purely based upon debt that banks were trading, not debt that banks had in their vaults. 

Now I blogged a while back about the fact that Europe’s banks held over $1 trillion in debt to just Greece and Spain (double click picture to enlarge):

With sovereign debt trading on the bank's books worth about a tenth of their total exposure, that means that around $900 billion of potential sovereign debt has been ignored.  How this can be ignored is beyond me.

Secondly, the tests ignore any liquidity risk issues, and just looked at market and credit risks. Why?

This crisis started with liquidity risk when interbank lending dried up, and then exploded when sovereign debt became a major concern. The fact that CEBS left out these two clearly important dimensions just seems silly.

But then it is purely a politically motivated exercise to try to stop the haemorrhaging of confidence in the European system.

Now, I actually went to the press briefing on Friday night – a time chosen to ensure that markets could not react immediately to this sham – and saw the baying hounds of the media looking totally incredulous as the headlines were announced.

“We have seven bank failures that, between them, in the most adverse scenario would need €3.5 billion of new capital.”

I’m sorry, but that’s nuts.

When the Americans did their stress tests, half their banks failed and they needed $75 billion of new capital. So how come, in the worst of situations, our banks would only need €3.5 billion and fewer than 10% fail?

Because it’s a fix.

It’s fixed because each country interpreted the stress test conditions for unemployment and house prices and other economic conditions in their own way.

It's fixed because each regulator and central bank applied the test conditions against their bank's balance sheets in dfferent ways.

And it’s fixed by leaving out the sovereign debt exposures and potential defaults on the bank’s books.

Nevertheless, something useful did come out of it: data.

There's lots of data about the state of the bank's balance sheets released by CEBS that can now be analysed by the markets, rather than the fudge that the regulators applied.

Therefore, with the reservations stated above, I went through the numbers over the weekend and found an interesting result.

First, a little explanation of the numbers.

The tests are based upon three scenarios.

Scenario 1 is the benchmark, which is based upon the current ECB forecasts for macroeconomic developments across the European Union.

Scenario 2 is then based upon a double dip recession, which sees no growth in 2010 and a 0.4% downturn in GDP in the European Union in 2011, versus 1% in 2010 and 1.7% forecasted in the benchmark.

Scenario 3 studies the impact of a sovereign debt shock to the European Union on top of this recession, and is geared towards higher debt losses and impairments in the PIGS – Portugal, Ireland, Italy, Greece and Spain – than in other countries.

This does not assume a sovereign default, just corporate debt and sovereign debt on the trading books of the banks. That’s about 10% of the total exposure for the banks, should a country default.

In the CEBS tests, they looked at Tier 1 Capital Ratio – not core capital, just Tier 1 capital – and said that the ratio should not fall under 6%. Under the EU Capital Requirements Directive, as it stands uncorrected since this crisis hit, the lowest level by law is 4%. Meanwhile, the likelihood is that a minimum 8% Tier 1 Capital will be required in the future and, in this context, is a far better ratio to apply.

For example, based upon the CEBS view of the world, using the combined worst case of a double dip recession and a sovereign debt shock, they find seven banks would fall under the 6% Tier 1 Capital Ratio level: five in Spain, one in Germany and one in Greece.

Looking at the numbers using an 8% Tier 1 Capital Levels - a level that is rumoured to be required under revised terms for EU bank trading in the future - 39 banks would fail in the worst case scenario: one in Austria, one in Cyprus, five in Germany, three in Greece, two in Ireland, four in Italy, one in Portugal, one in Slovenia and twenty one in Spain.

Figure 1: 8% Tier 1 Capital Measures Failed by 39 Banks (double click image to enlarge)

Figure 2: Banks that Pass the 8% test (double click image to enlarge)

That would have been a far more realistic number to have announced and, based upon the fragmented application and interpretation of the tests by member states, is probably more likely to be the worst case scenario than the seven bank fails CEBS announced last Friday.

NOTE: failure does not means the banks are insolvent just undercapitalised, and so this would have been a much better way for CEBS, the ECB and the European Commission to have achieved some credibility from this exercise.

Skinner Says Stress Test Methods 'Pretty Weak' - Washington Post

Bloomberg appearance, 26th July 2010 from Chris Skinner on Vimeo.

Meanwhile, if you’re interested, here are the CEBS documents related to the stress tests:

• CEBS Press release (pdf)
• Summary report (pdf)
• Q & As (pdf)
• Joint Press Release CEBS, ECB, European Commission (pdf)
• Summary of the 91 bank-by-bank results, by country (pdf 5MB)

And a few of the more interesting tidbits that I picked up when looking at the background to these tests:

“According to a survey by Goldman Sachs, 10 of the 91 banks subjected to the stress tests are expected to fail. The poll of 376 respondents, shows that European banks are expected on average to raise £40.6bn in extra capital following the tests.” Money Marketing

“Hypo Real Estate’s Tier 1 capital ratio was 7.7 percent at the end of March, according to a presentation on its website dated June 2010. The lender said in May that it holds 72.1 billion euros ($93.4 billion) of debt in Greece, Italy and Spain, among the highest held by a bank in Europe, according to data compiled by Bloomberg ... Germany’s Soffin bank-rescue fund had provided Hypo Real Estate with 7.87 billion euros in funds by the end of March. The bank has said it may require a total of 10 billion euros from the fund. The lender said on July 8 that it received approval to establish a so-called bad bank to transfer as much as 210 billion euros of investments consisting of ‘non-strategic assets and risk positions.’ The amount represents more than half of Hypo Real Estate’s total assets at the end of 2009.”  Bloomberg

“According to CEBS, the other German lenders tested are Deutsche Bank AG, Commerzbank AG, Deutsche Postbank AG, Landesbank Baden-Wuerttemberg, Bayerische Landesbank, Norddeutsche Landesbank Girozentrale, WestLB AG, HSH Nordbank AG, Landesbank Hessen-Thueringen Girozentrale, Landesbank Berlin AG, DZ Bank AG, WGZ Bank AG and DekaBank Deutsche Girozentrale ... Among the banks on the list above, we note that e.g. Commerzbank has leverage of roughly 150:1 (tangible assets divided by tangible common equity), Landesbank Berlin has leverage of 75:1, WestLB 68:1 and Deutsche Bank 56:1. For the sake of comparison, by the time of its demise, Lehman Brothers is said to have been leveraged about 30:1. How can any of these banks not be de facto insolvent? If they hold any PIIGS bonds at all (and some of them do, in spades – e.g. 468% of Commerzbank's tangible book value was invested in PIIGS bonds as of about six weeks ago), it is a near mathematical certainty that they are.” Pater Tenebrarum

Revising MiFID and RegNMS for HFT

Gawd, I hate acronymns and look at that!  Three in one blog entry title!!!

Anyways, for the nerdy-nerd equities guys, this will grab their attention.

It's all to do with trading in European and American stocks and shares using High Frequency Trading (HFT) systems, and the regulations therein with EU MiFID rules applying over here and USA RegNMS rules applying over there.

These rules are going to be overhauled soon thanks to the Flash Crash, that dreaded thing that caused US stock markets to go haywire on May 6th.  There has been lots and lots written about the Flash Crash of May 6th, but there’s not been a great deal saying it was a good thing ... until you meet JPMorgan.

In this week’s Eye on the Market, they identify five things they like about the Flash Crash, namely:

[1] Stock-specific circuit breakers.

The U.S. has been slow to install circuit breakers on major exchanges, relying instead on “clearly erroneous trade rules” that cancel trades after the fact. In Asia and Europe, circuit-breakers have been around for a while. In Asia, trading is restricted outside of pre-specified daily bands of 5%, 10% and 15% (different by market). In Europe (e.g., Deutsche Bourse), trading is halted for 5 minutes after a 3%-10% move, and then reopened. In the wake of the Flash Crash, 10% circuit breakers are now applied to a few stocks as part of a pilot program (they have already been triggered on Citigroup, Anadarko and the Washington Post Company). If we are going to exist in a world with automated robots doing the lion’s share of daily trading, circuit breakers may be needed to prevent unintended and unmanageable meltdowns.

Another topic under discussion by the SEC: prevent HFTs from having “unfiltered, naked access” to the exchanges by requiring them to live by the same pre-trade risk management controls that clearing members do. Why? As noted by the Chicago Fed, “high-frequency trading has the potential to generate errors and losses at a speed and magnitude far greater than that in a floor or screen-based trading environment”.

[2] More balance to the HFT discussion.

HFT supporters claim they are providers of liquidity to the market, and that HFT makes U.S. markets more efficient than ever. Suggestions to the contrary have been deemed “utterly laughable” by firms defending them. However, the Flash Crash highlights the uncertainties around these assertions.

While volumes have tripled in the last few years, there’s a big difference between volume and liquidity (the ability to transact without moving the price). In an industry barometer survey1 conducted by the Tabb Group in May of this year, barely half the participants had a high degree of confidence in the US equity market structure; 73% did not believe the market structure is “orderly”.

One of the survey recommendations: HFTs should be required to register as broker-dealers.

To be sure, there were weaknesses in the old specialist system as well2. But specialists were required to maintain a fair and orderly market, and post quotes that were part of the National Best Bid and Offer system; their reputations mattered. HFTs have no such requirements (no minimum shares or minimum quote times); one proposal would require quotes to be valid for at least one second. The SEC has broadened the trader reporting system in order to analyze HFT activity more closely.

[3] Proposals requiring HFTs to act more like the floor specialists they’re replacing.

With the advent of HFTs, cancelled orders have soared. Today’s ratio of 30 cancelled orders for each one executed means that 97% are cancelled.

To curb abusive practices, some market participants recommend applying a fee to HFTs for an excessive number of cancelled orders. The increase in cancelled orders is one reason we do not agree that increased order depth on S&P 500 stocks at the NBBO is a clear indication of greater liquidity, as some market research alleges. Quotes pulled within a nano-second of being posted, and which are part of an algorithmic order detection exercise, don’t seem like liquidity in the traditional sense. Ameritrade’s representative on the recent SEC Roundtable referred to this as “opportunistic liquidity”.

[4] More discussion around HFT “co-location”.

Some HFTs co-locate computer servers inside stock exchanges3 to minimize the milliseconds (or nanoseconds) required to scan existing orders, and have algorithms act on this information. As trading execution and IPO listing fees declined, exchanges have tried to make up the difference by selling access to market data. Some exchanges have products which give clients a faster look at quotes, in exchange for a fee. As a result, some HFTs end up with access to information sooner than institutional or retail investors who rely on more standard venues (such as SIP Quotes).

The search for co-location benefits has existed forever (in polite company, “order anticipation strategies”). Broker-dealers in past decades argued that being closer to floor traders on the CBOT was an advantage to their clients. But historical parallels can lose their meaning when the instruments of battle change: one HFT computer can reportedly decode more than 5 million messages per second. The Flash Crash has increased the debate around whether co-location confers advantages to HFTs, and whether there should be obligations and responsibilities that accompany them.

[5] Asset managers learn that “cheapest <> best”.

After the NYSE moved to decimalization in 2001, bid-offer spreads fell almost in half on S&P 500 stocks (less so for the Russell 2000 stocks, where HFTs are less active). Schwab retail commissions fell from $35 in 2003 to less than $10 in 2009. This trend is confirmed by broader research from the American Association of Individual Investors. So if the prism of success is bid-offer costs and commissions on individual trades, the battle has been won.

But is that the right prism to define what makes an optimal marketplace? Part of the HFT industry tracks the order flow of larger investors who leave electronic footprints4. Using algorithms which include spraying the tape with thousands of quotes, the intentions of large investors is ferreted out. This can result in higher trading costs for such investors, and by extension, their clients, who include 401k investors, and pensioners participating in state and corporate plans. Quantitative Services Group computes analyses of HFT impacts on execution costs. They estimate that HFT tracking algorithms can drive execution costs up 1.5 to 3 times, even when institutional investors parcel trades into smaller orders to avoid detection.

There’s lots more of interest in their report, which you can read in full and download if you want:

JPMorgan's Eye on the Market

Meanwhile, you may note that a lot of it is about High Frequency Trading (HFT), which I’ve written quite a bit about recently:

• Who's afraid of HFT, HFT, HFT?
• High frequency trading in jeopardy thanks to flash crash
• More Banking Statistics: Algo and High Frequency Trading

as have many others.

This means that this area is going to get regulated, and it will mean significant restructuring.  For example, back in January, the SEC started a consultation through the Concept Release - a request for public comment on securities issues - on HFT and more.

Key areas under review include:

Market Quality Metrics

What are the best metrics for assessing market quality for long-term investors and have these metrics improved or worsened in recent years?

Fairness of Market Structure

Is the current highly automated, high-speed market structure fundamentally fair for investors?

High Frequency Trading

What types of strategies are used by the proprietary trading firms loosely referred to as high frequency traders, and are these strategies beneficial or harmful for other investors?

Is the overall use of any harmful strategies by proprietary firms sufficiently widespread that the Commission should consider a regulatory initiative in this area?

Co-Location

Do co-location services (which enable exchange customers to potentially route trades faster by placing their computer servers in close proximity to an exchange's computer system) give proprietary trading firms an unfair advantage?

If so, should the proprietary firms that use these services be subject to any specific trading obligations?

Dark Liquidity

Has the trading volume of undisplayed trading centres (such as dark pools) reached a sufficiently significant level that it has detracted from the quality of public price discovery?

If more individual investor orders were routed to public markets, would it promote quote competition in the public markets, lead to narrower spreads, and ultimately improve order execution quality for individual investors beyond current levels?

Are a significant number of individual investor orders executed in dark pools and, if so, what is the execution quality for these orders?

Lots of comments have been received on the Concept Release, and its conclusion cannot be far away.

Now we have a European response to this area with Kay Swinburne, rapporteur to the Economic and Monetary Affairs committee of the Parliament, producing a draft report last week. This report provides indication of much of what might be in the revised MiFID and very little is left untouched.

Jeremy Grant over at the Financial Times, has picked out some of the more interesting nuggets from Kay’s report:

• She suggests it may be necessary for “informal market makers” – read: HFTs – to be subject to mandatory liquidity provisions;
• Calls for an “ongoing regulatory review” of the algorithms used by HFTs;
• Seeks an examination of HFT to determine whether market flow generated automatically is providing “real liquidity” to the market and what the effect of this is on overall price discovery;
• Suggests that, “in the interests of equitable treatment”, rules need to be introduced so that MTFs (multilateral trading facilities”, like Chi-X Europe) are subject to the same level of supervision as exchanges, under certain circumstances;
• Calls for new provisions under Mifid for “broker crossing networks”, including requirements that they submit to authorities “orders matched in the system”, and “details on access to the system”; and
• Suggests a minimum order size for dark pools.

This is pretty dramatic stuff and Jeremy finishes his column by referencing David Doyle, a regular speaker at the FSClub, returning to the London meeting on 12th January 2011 for our annual EU regulatory update.

David presented on the key changes in MiFID at a conference at the London Stock Exchange last week, stressing that “the whole review of MiFID will have as its driving principle investor protection – that is, the interest of the retail investor, not the operators of exchanges, dark pools and HFTs.”

Too true David, too true.

If you’re interested in more of what David had to say, here are his slides:

Mi fid, david doyle, july2010

View more presentations from Chris Skinner.

EU's bank stress tests creating more bank stress

It turns out that 91 European banks are to be put through a ‘stress test’ to see how well or badly they will cope with a shock to the system. The stress test itself was a little unclear until late last week, when the Committee of European Banking Supervisors (CEBS) detailed what would happen. As a result, a lot of folks think it’s a fudge, and the intention of creating more confidence in the EU’s banking system may actually have achieved the opposite.

Here’s the lowdown.

CEBS stress tests were announced after their initial approach was viewed as being too little and too narrow. The intention was to stabilise confidence in the EU banking system following the crisis in the Eurozone, and the approach was meant to follow the example set by America in May last year.

Back then, everyone felt the American banking system could not deal with the exposures they had to OTC derivatives, so the Federal Reserve tested the banks to see if they could deal with not just those exposures, but any other severe shocks to the system.

The US tests used two economic scenarios: one mirroring the consensus of economic experts on the course of the downturn through 2010, and the second modelling a worse-than-expected course of economic activity.

This resulted in recognition of a $74.6 billion shortfall, which was far less than the figures being bandied around before the stress test results. For example, the IMF estimating that the U.S. banks needed another $275 billion to $500 billion whilst some analysts throwing figures around that the industry may need as much as $1 trillion.

The less than anticipated shortfall led to increased confidence in the American banks. That confidence led to some stability in the system thereafter, financial stocks jumped 36% in the seven months after the tests, which is why it was worth doing.

This is why the US example was followed by the lengthy discussion of living wills in the UK regulatory sector, and the idea of reverse stress testing as implemented by the FSA last December. In these tests, banks are meant to imagine that they have failed and then have to work backwards to determine which risks and vulnerabilities caused their hypothetical collapse.

The FSA’s approach to stress testing consists of three main elements: companies’ own internal stress testing, where they assess their ability to meet capital and liquidity demands in a sudden downturn; the regulator’s testing of specific companies; and simultaneous “system-wide” stress testing, based on a common crisis scenario.

In both the US and UK examples, the stress test methodologies were completely transparent and now we come to the European bank stress tests.

In the EU tests, CEBS will study 91 banks, mainly in Spain and Germany, but also several other key banks including Britain's "Big Four" – RBS, HSBC, Barclays and Lloyds. In the latter example, thanks to the FSA’s scrutiny, they have already been subject to tough tests at home and should pass with flying colours.

The list is actually considerably longer than the original announcements in June which selected just 25 banks for review, and includes the German Landesbanken for the first time.

The significance of that decision cannot be underscored more deeply as BaFIN, the German regulator, announced a year ago that €800 billion of toxic debt sat on the balance sheets of these banks, particularly some of the Landesbanken, and that was double the amount they had estimated just three months earlier.

With almost $1 trillion in deposits, 2,500 banks and 45,000 branches, Germany also has one of the densest banking networks in the world, and hence a weakness in the German system would be a weakness for all, particularly as Germany has been bailing out Greece and, soon, Spain, Italy, Portugal and more.

In Spain’s case, as recently blogged, there is a big problem with the mid-size banks where the savings banks, regional banks and mid-sized banks are all closing, merging and consolidating, with anything from a quarter to a third of all Spanish bank branches to close.

That’s not good.

But the stress tests can turn this situation around by showing that Europe can cope with even the worst case scenario.

That’s a tough call, as we are all asking: ‘Can it?’

After all, a stress test if it turns out to be negative will worsen the situation but, if it’s positive, it will improve everything.

So the stress tests are being reported to be as transparent as the US version, with a three scenario test, according to the German newspaper Handelsblatt.

The first will analyse how banks perform if economic growth is at the rate forecast by the European Commission; the second will test the effect of a 3% drop in gross domestic product; and the third will look at how banks would cope with a "shock" situation in government bond markets, a scenario similar to events in May this year when Greece was downgraded by Standard & Poor’s.

It is that downgrade which has caused all of these jitters anyway, and created the uncertainty and lack of confidence in the Eurozone. Without confidence in the European banking system, then even worse scenarios could be considered, such as the collapse of the Eurozone and a return to national boundaries and nationalistic tendencies therein.

But there is already an issue with the European stress tests as the approach, structure and details of the tests have been changing over time, and many think the results – to be announced on 23rd July – will be a fudge. This view was given even more fuel when there were rumours that France and Germany were trying to suppress the methodology to be used for the tests.

This is bad news, as the lack of confidence in European banks will be made worse when or if there is a lack of confidence in the European banks’ stress tests, and the stress tests will only increase market uncertainty, rather than decrease.

All in all, my view is that Europe is caught between the Devil and the Deep Blue Sea.

If they complete the stress tests and release the results with complete transparency, there is likely to be some fallout. Unless the results show that the fears for bank counterparty risks in Europe are unfounded, which in the case of the Landesbanken and Spanish caja banks is unlikely, then it will just confirm what many already suspect: Europe’s broke.

On the other hand, if they complete the stress tests and release the airbrushed results that show some manipulation or opaqueness, then everyone will believe that their fears for bank counterparty risks in Europe are proven.

Therefore, what seemed to be a great idea to bolster confidence in the Eurozone may actually prove to be a lose-lose situation.

So how can the Eurocrats create a win out of this?

Just be totally honest.

If there are real issues in the heartland of Europe’s banks, be brutally frank about them.

It is only with total honesty, transparency and clearly washing any dirty laundry in public at the end of the month that Europe has any hope of surviving this current battering.

More Banking Statistics: Home Ownership

Following on from the comments on UK Bank Stats from the BBA, and the report from TheCityUK, here's a few more statistics focused upon home ownership.

Just a century ago, nine out of ten homes were rented in the UK compared to only one in three today.

Since 1976, owner-occupier households have risen from 55% of all households to 66% today. Meanwhile, local authority housing provided by government councils has gone down from a third of all housing to just 1 in 20 today.

Thank you Margaret Thatcher!

Equally, I wonder what this picture will look like in two or three years, as the credit crisis and house price slump looks likely to continue in the UK.

Either way, this still does not make the UK the largest home owning nation of Europe. That award goes to Hungary and Romani.

Hmmm ... is that why Romania’s Gypsies are so well known? 

Charts sourced from TheCity UK report

Think the unthinkable

Many interesting, weird and wonderful things drop into my inbox, Facebook newsfeed and twitter status updates.

Take yesterday.

I was sent:

• a copy of the BBA’s Annual Abstract of Banking Statistics,
• lots of notes from my accountant,
• various invites to press shindigs,
• a note from FatBoy Slim, who is an England groupie at the World Cup,
• a disgusting PowerPoint show detailing World Cup supporters of the opposite sex,
• a solution for the issues Apple iPhone4 users are having with signal loss if they hold the phone the wrong way around

• 

• and a note from my conspiracy theorist friend about the weird coincidence that, on 7th July 2005, a company was running a simulation of a terrorist attack in London using the exact situation that became a reality that very morning.

How coincidental was that?

Anyways, talking of simulations, I am also getting lots of emails from bank economists with the title generally being: THINK THE UNTHINKABLE.

The one that really grabbed my attention was from ING, looking at what will happen if the Eurozone collapses.

We’ve had this discussion a few times lately, since Greece and co have been under duress, but no matter how much dialogue there is over this, it never seems to quite go away.

But I’ve not seen a bank analysis of the consequences of a Eurozone breakup before.

Here’s the opening lines:

“Suddenly the unthinkable is thinkable. The possibility that one or more of the members of European Monetary Union (EMU) might leave is no longer being dismissed, even by Eurozone politicians. In this report, we discuss not the probability of this – readers will doubtless have their own views – but rather its potential economic and financial market impact. Complete break-up would have effects that dwarf the post Lehman Brothers collapse.”

Oh dear.

The report is written by Mark Cliffe, Global Head of Financial Markets research, who looks at two scenarios: what happens if Greece leaves the euro and what happens if the Eurozone falls apart.

The first scenario is bad: “While the initial economic damage of a Greek exit is naturally focused on Greece itself, the effects elsewhere are non-trivial. While Greek output falls by 7½% relative to our base case, the remaining Eurozone economies could see their output fall by as much as 1%. Losses on Greek assets spread the pain across Europe and beyond.”

The second is horrible: “the impact of complete break-up is dramatic and traumatic. In the first year, output falls by between 5%and 9% across the various former member states, and asset prices plummet. With their new currencies falling by 50% or more, the peripheral economies such as Spain and Portugal see their inflation rates soar towards double-digits. Meanwhile, Germany and other core countries suffer a deflationary shock. Indeed, with the US dollar surging on safe haven flows to the equivalent of 0.85 EUR/USD, the US also suffers a bout of deflation.”

He concludes that: “without extended preparations for EMU exit, the risk of at least a temporary breakdown in payments systems would be enormous. In our complete EMU break up scenario, the cumulative loss of output in the first two years is close to 10%, dwarfing the loss that followed the collapse after the demise of Lehman Brothers in September 2008.”

Yeuch.

So I do wonder what our banks are doing to protect us from such a disaster by preparing contingency plans for the Eurozone collapse. Believe me, they are creating contingency plans.

Mind you, it’s more cheery than the note I got from the economists at the Royal Bank of Scotland, who “strongly believe that a cliff-edge may be around the corner, for the global banking system (particularly in Europe), and for the global economy (particularly in the US/Europe).”

This one is written by Andrew Roberts, who is “amazed there is not now immense market & media focus on the new letters that will bring forward the end-game and worsen it.”

The 'new letters' to which he refers is the SEC Rule 2a-7 which came into force on 30th June, and demands that US money market funds take a safer position when it comes to their investment policies.

There’s US$2.8 trillion of 2a-7 funds, and this rules demands that they now own 30%, not 5%, of assets in sub 7-day liquid paper. In other words, money that is available for access if liquidity is needed within seven days.  This means investing a third of the portfolio in short-term bonds and gold, whilst avoiding longer term investing in things such as ... er, sovereign debt.

“We can all see the logic – the sovereign defaults from EMU have the power to hit EMU banks badly, and the USA does not want to repeat the calamitous ‘breaking the buck’ problem when” they let Lehmans collapse.

Mr. Roberts believes that “the USA is basically pulling up the drawbridge and retreating into its fortress, trying to protect its financial system from coming European banking problems. But the consequence is clear. Banking is about confidence. If you are reliant on markets to fund yourself and that confidence wanes, a total stop can occur immediately/within days. Northern Rock (75% reliant on wholesale markets) was the first example of this in the UK, though not the last. Once we apply 2a-7 to our economic slowdown/deflation themes, this means one thing. If there is a slowdown and sovereign trouble, the problems facing EMU banking have through this rule potentially become a whole lot worse. This worsens – and brings forward – the ‘cliff edge’ potential.”

Jeez, this sounds serious although one of my mates tweeted a response: “surely history tells us RBS haven't the faintest idea what the economy might or might not do?”

Thing is that it’s not the end of it.

Morgan Stanley, for example, put this chart in their gloomy outlook:

And state that: “euro area banks’ exposure to the EMU periphery could amount to about €140 billion. Germany’s banking sector seems most exposed to Spain, France’s to Greece and Spain’s to Portugal ...

European banks are more wholesale-funded than any other major banking system. According to our equity analysts, European banks have €3.3 trillion of senior wholesale funding – almost half due in 2010-12. We think that providing extra liquidity might help to buy time, though the fundamental problems are unlikely to go away very easily. Bank recapitalisation, further fiscal restraint and structural reforms might help to address the underlying issues.”

Looking at the other economic outlooks, thye’re all talking about the euro, the Eurozone and the probability of a double-dip recession being high.

That blows my tracker fund investments then.

Guess, I'll just have to put all my money on the Netherlands winning the World Cup finals.  After all, going Dutch only means spending half of the cost rather than having to take all of it!

The World's Top 20 Banks 1994-2010 ... Anglo-American Banking Rules!

I’ve just received this month’s Banker magazine which the editor, Brian Caplen, describes as their most important issue of the year as it covers the latest Bank 1000 listings.

This year’s listings show a surprisingly stable crew of American and British banks.

World   Bank                               Tier One              Pre-tax
Rank                                            Capital                profit
                                                      $m                    $m
1        Bank of America Corp        160,387.77           4,360.00
2        JP Morgan Chase & Co       132,971.00         16,143.00
3        Citigroup                          127,034.00          -8,445.00
4        Royal Bank of Scotland       123,859.00          -4,366.29
5        HSBC Holdings                   122,157.00           7,079.00

Considering the crisis was meant to have killed these banks, you may find it surprising to see that Citigroup and RBS have maintained their leading positions.

This is down to the fact that the Banker measures a bank’s strength by its Tier 1 Capital, and so their positioning is more of a reflection of the sheer size of these firms than by their brand or market capitalisation, which is used in some other studies of size.

The Banker’s data is fascinating though, as the database also contains profitability, revenue, cost-income ratio and more, so it’s a useful tool in all senses.  And the online data goes back to 1996, so you can do some useful comparisons.

Mind you, my data - old Banker magazines - goes back even further so I quickly took a snapshot of a few useful year’s – 1994, 1999, 2004, 2008 and 2010 – to see how things have changed.  Mapping out the Top 20 banks of the world for each year makes for an interesting picture (doubleclick the picture to see a larger version):

Back in 1994, Japan ruled the world.

Then their economy went South and Origami Bank folded, Sumo Bank went belly up, Bonsai Bank cut back their branches and something fishy went on at Sushi Bank where staff got a raw deal.

Post-Japan’s slump, the Anglo-American financial system ruled. So you would think that, as that system failed, it also would have gone South.

Not the case.

Maybe that’s a reflection of the sheer scale of investment American and European firms have put into these economies to avoid such a crash.

Well worth spending time looking at the data and looking forward to playing around with it further.

Europe is from Mars, America is from Venus

For some time now, I’ve been meaning to blog about the big issue bubbling away over SWIFT, and the access to SWIFT records demanded by the US authorities.

I remember having lunch with some executives at SWIFT back in the summer of 2006, when the news first broke about this. Back then, the New York Times had just broken the previously secretive story that SWIFT was sharing bank data with the US authorities, after having been subpoenaed to share such data. The aim was to track terrorist funding and any transactions that involved suspected terrorist related activities were shared.  The problem is (a) what right does the USA have to subpoenae and access the records of a Europe-based institution and (b) how does SWIFT ensure it's just limited to terrorism records, and not the records of you and I.

SWIFT weren't happy about this action, and particularly that it had now come into public domain.  One SWIFT executive said to me: “when that New York Times journalist is walking around the next Ground Zero and sees the thousands of bodies caused by his exposing this story, see how happy he is then.”  Over a glass of wine, he admitted that he’d like to crush the bones of the journalist and bury him six feet under.

You see SWIFT is meant to be private. It’s a bank consortia, and not meant to be open to any old authority raking over its records.

And, bearing in mind that SWIFT is head officed just outside Brussels in Belgium, the centre of and capital of Europe, having some gung-ho Yankees barking orders at them does not go down well.

Nevertheless, in the spirit of cooperation, the European Commission, Parliament and politicians have been trying to work hard to come up with something that meets the needs of the American authorities whilst not compromising our very European principles.

It won’t work.

But we’ll try.

You see, when it comes to privacy, Europe is from Mars and America is from Venus. Europe believes the individual has a basic human right to protect their privacy. America believes that the State is far more important than the individual, and so listening in to any conversation, no matter how private, is fine.

This is all coming to a head as Members of the European Parliament are debating this topic this week and pushing through a revised agreement with the United States on Wednesday.

This follows the block on the original deal in February, which was meant to allow a continuance of the access that came to light in 2006. That was blocked due to ‘insufficient data privacy safeguards’.

The amended agreement now states that the USA can request European financial data relevant to a specific terrorist investigation, as long as they substantiate the need for the data.

The whole argument over data privacy is illustrated best by this discussion between Frank Gaffney, a lobbyist for US Security, and Baroness Sarah Ludford, MEP, on the BBC’s Radio 4 programme “The World This Weekend”, aired yesterday and presented by Shaun Ley.

The World This Weekend, 4th July 2010 from Chris Skinner on Vimeo.

Shaun Ley: If you pop down to the garden centre or a supermarket this afternoon, what you buy could end up being examined by the Pentagon.  As part of the fight against terrorism, the United States has been seeking authority to receive details of any personal financial transactions from Britain and other European countries. Since 9/11 they’ve had some access informally but, in March the European parliament blocked a government level agreement on data transfer, worried about the threat to privacy. On Wednesday, MEPs will vote on a renegotiated deal.

Frank Gaffney, who was responsible for international security in the State Department under President Reagan, thinks it’s about time.

I’ve been speaking to him and to Baroness Sarah Ludford, Liberal Democrat MEP, who’s been telling me about her concerns including something known as ‘data drilling’.

Baroness Sarah Ludford: Well, rather than searching specifically for a name of a particular individual or particular data in a bank account, you would do a big trawl. A fishing expedition, as it were. Now we haven’t got 100% perfection and we are still concerned that it involves the bulk transfer of data. So European banking data is transferred en block, in bulk, to the United States and it is searched there. What we would like and we have got certain commitments that in the medium term, the option will be explored and hopefully developed, of the data being extracted in a targeted way on European soil. So we don’t have to hand over this mass of undifferentiated data, because clearly there are concerns about that.

Ley: Frank Gaffney, from the US perspective, your authorities wanted this data and wanted this opportunity. Why is it so important to be able to drill down into people’s bank details in that way?

Frank Gaffney: We are confronting enemies that are increasingly sophisticated. Getting insights into the movements of funds that enable this kind of activity to take place is, I think, essential to countering these sorts of threats, both of the violent and of the stealthy kind. The more hamstrung we are, the more likely it is that these sorts of seditious activities will go forward with ever greater success. That’s something I don’t think we can tolerate.

Ley: And are you worried that these kinds of restrictions that are being negotiated with the EU might leave the investigative powers hamstrung?

Gaffney: I do worry about that. I think that’s sort of the object after all, is to constrain those investigatory efforts in the interest of privacy. I like my privacy, like everybody else. I just don’t want to die.

Ley: So a lot of these changes potentially put lives at risk.

Ludford: I don’t believe so. I strongly believe in trans-Atlantic cooperation in a whole series of areas. I’m vice-chair of the European Parliament’s US delegation. We don’t have reciprocal right to US banking data and some of us have wondered what Congress, and the Senate in particular, would say if Europe was to request that the banking data of all US citizens was to be transferred in bulk, en block, to Europe.

Ley: Frank Gaffney, that’s fair enough isn’t it. If you’re going to be given access to my bank details, shouldn’t that work the other way around as well?

Gaffney: I can’t speak for the US government obviously, as I’m not a government official anymore, but I suspect that one of the reasons why there might be a resistance to the kind of reciprocity that seems otherwise unobjectionable and fair, is to the extent that European governments and maybe even the European Parliament itself, have been penetrated by folks who are sympathetic to or actually working for organisations like the Muslim Brotherhood. That would be a real problem from the security point of view that I’m talking about.

Ludford: I can assure you that that is not the case.

Gaffney: I can assure you that it is the case.

Ludford: I don’t like this portrayal somehow of Europe is Venus and America is Mars. I think that is a gross misrepresentation. It’s not about being soft on terrorism but, specifically among the Muslim community, we do need leads and cooperation with the police in that community so you have to be, for law enforcement purposes, quite intelligent about the way you seek to isolate the real terrorist suspects from the bulk of the community.

Gaffney: I agree very strongly with that, but I don’t believe it is intelligent to embrace the Muslim Brotherhood and organisations like that.

Ludford: I don’t think anybody is suggesting that it is.

Gaffney: I can assure you ma’am that that is being done in Britain, it is being done in the Continent of Europe, it is being done in the European Parliament.

Ludford: I can assure you that the European Parliament MEPs are not at all motivated by concern for the Muslim Brotherhood in our insistence on stricter data protection privacy safeguards.

Gaffney: I can simply assure you that it is absolutely a point on which you agree with the Muslim Brotherhood. Whether you are doing it at their behest, or whether you are simply doing it in parallel, is beside the point to my way of thinking.

Ludford: I think that is really unhelpful. I’m sorry, I just find that so unhelpful to somehow cast aspersions on anyone who is championing data protections and saying – whether it’s our banking data, our email, our internet usage, our phone calls, travel information – that it ought to be open season for law enforcement to go fishing around in it all because if you don’t agree to that, you are somehow a front for the jihadists. I think that is so absurd that we can’t discuss this sensibly.

Gaffney: That is not what I have said.

Ludford: Well it comes pretty close to what you said.

Gaffney: What I’ve indicated in the comments so far is that there is an obvious need for a balance between privacy and the need to defend ourselves, especially when civil liberties are being used by our enemies as part of this stealth jihad to undermine and to destroy us.

Ludford: MEPs have spoken on behalf of the majority of people, who are not the ones you are talking about, and I’m sure that MEPs will next week support this new agreement because it has two effects. One is indeed to try and make sure that we can combat terrorism through finding out about terrorist financing, but it also does so under pretty strict safeguards for data protection, and I think that is a win:win situation.

Ley: Frank Gaffney, your last word?

Gaffney: I just hope you’re right. We’ll see.

Y Viva Espana ... nein

Over the past week, I’ve spent time conferencing in the Spanish cities of Barcelona and Santander. In the case of the latter, my family thought I was going to a conference in the bank’s vaults, and I had to get a map out to show them that there actually is a city called Santander.

Now Spain has had a right old drubbing lately. Breathed in the same breath as Greece, Spain is viewed as being on the brink of failure and could bring down the Eurozone all on their own, although Portugal, Italy and Ireland may also have a say in this.

Their only saving grace is that they actually have a football team who played in this World Cup, unlike France, England and Italy.

Mind you, the Germans are also playing some pretty neat football with Sebastian Schoepp giving Spain a good kicking in the German newspaper, Sueddeutsche Zeitung.

The tone of his article may be summarised as follows:

Spain was a country full of donkey trails and decaying villages but now has the fourth largest Eurozone economy, behind Germany, France and Italy. But its economy is all built on sand, as it was all developed using the unsustainable property boom, where Spanish businesses sold sunshine to Brits, Germans and Scandinavians. The sad fact is that Spaniards have been living beyond their means and now need to pay the bill. Its banks sit on mountains of bad loans and foreign speculators will sell Spain short just as Sir Francis Drake did to their galleons three centuries ago (is this guy not English?).

OK, Spain is a bit of a sick dog of Europe, but is it really that bad?

In some respects, yes.

At the banking conferences I attended, a common theme is that Spanish banks over-expanded and now need to retrench. For example, there is a move to close down at least a quarter and maybe a third of all Spanish bank branches.

How come so many, I ask?

The answer is given to me that so many branches were opened to support and fuel the property boom that these branches are now desolate, unwanted, unnecessary and unforgiven.

Banks are on the back foot ... but not all banks.

I recently blogged about how Spanish banks are thriving in social media. But these are the big banks and community banks. Savings banks, regional banks and mid-sized banks are all closing, merging and consolidating.

Apparently, Zapatero’s government has been actively pushing for banks to merge rather than close, although regional and local governments across Spain also have a say in this.

Meanwhile, the economy sinks further with unemployment at 20%.

This makes Spain's economic mess one of the worst in the Eurozone.

In reality, that figure is underestimating anyhow, as these figures vary by city, town and village, with the average rate reportedly running at 25% unemployed rising to almost half the population in some areas.

Add onto this over developed property markets that cannot shift property, and this will continue to be an issue for the longer term.

The Spanish construction issues are also made worse by the fact that, like Dubai, a lot of the developments involved migrant workers from Eastern Europe, South America and Africa.

Money movement corridors for remittances are therefore well developed in Spain, but these have been impacted too.

First, many migrant workers have gone home as there is no new construction taking place.

Second, volumes and values of remittances have gone through the floor.

Third, there are too many money transfer agents.

On this third point, that's for a reason.

According to the remittances conference I attended last week, there are around 25,000 money transfer agents in Spain which is almost the same number as America, and these figures need to come down to around 10,000.

But then someone else tells me that Spain doesn’t have 25,000 agents. It’s just 10,000 but with 2.5 exclusivity licences each.

What?

Well, most money transfer operators want their agents to be exclusive.

This may be a problem but not for Spanish agents who have been getting around such rules for years. For example, papa signs an exclusivity agreement with Western Union, mama signs one with Moneygram and bambino signs one with Travelex.

This is going to change as the Payment Services Directive (PSD) says that money transfer firms cannot have exclusivity licences.

Well, says my Spanish remittances friend, the PSD is irrelevant here in Spain as we use derogation rules to get around anything that might cause an issue or impact our domestic markets.

Ah well, that’s Spain for you.

And this is why the German journalist was so vitriolic, as he’s not only worried that Spain will be another Greece but that, with their lackadaisical attitudes towards rules and regulations will be much worse.

This could be much more of a drag on the German economy and the Eurozone as a result.

To make matters worse, the FT reports today that the European Central Bank (Frankfurt!) has just put the hee-bee gee-bees up the Spanish Banks sails by refusing to extend their loans:

Spanish banks have been lobbying the European Central Bank to act to ease the systemic fallout from the expiry of a €442bn ($542bn) funding programme this week, accusing the central bank of “absurd” behaviour in not renewing the scheme.  On Thursday, the clock runs out on the ECB financing programme – the largest amount ever lent in a single liquidity operation by the central bank – under the terms of the one-year special liquidity facility launched last summer.

Oh dear?

Will this push Spain to the brink and, therefore, the Eurozone?

Is there any optimism here?

Maybe.

Spain does have problems, but many of the conference attendees told me that they think they are getting over the worst of it.

The exodus of migrant workers has halted, and volumes and values of money transfer are now stable.

The property disaster may come to an end.  OK, it’s unlikely that Brits, Germans and Scandinavians are going to come back to Spain with remortgages for second homes, but retirees and holidaymakers still want sunshine.

And, for all of its foibles and practices, Spanish folks are nice people to get along with. Sure, some folks might want to kick ‘em up the rear-end but that doesn’t mean kicking them when they’re down if we're serious about a European Union for the future.

And finally, for all of Spain’s economic issues, it’s still not a bad place to be.

However none of the optimisms above fix the loan mountain that Spanish banks sit on.

In summation, don’t expect Spain – or Portugal, Ireland, Italy and Greece – to get their act together fast or to sort out their issues without further hostility and acrimony between Europe's nations.

The EU will have its biggest test for the next decade to see if it’s getting its act together. In fact, as Gideon Rachman said in the Financial Times last week, Europe is having a midlife crisis and some folks emerge from a crisis with a new sense of purpose whilst others just get divorced.

Unless Europe continues to behave in a united fashion, where Germany and France keep banging the drum of the Eurovision, then we may well go back to a disenfranchised and disenchanted Eurozone.

A broken one.

And I guess that it is the net:net of my Spanish reality.

For the European Union to continue, it really just boils down to whether Germany and France can keep it together.

Oh dear ... think I’ll go down the pub to watch Spain and Portugal battle things out in the World Cup finals.

Sources: Private Eye for the cartoon and Fabio joke, and The Week for the links to articles

BIS report French and German banks $1tn exposure

French and German banks have almost $1 trillion exposure to Southern European economies according to a Bank of International Settlements (BIS) report released last Monday (Download BIS report).

“Exposures” include loans, loan commitments, and derivatives contracts, and represent the cost to the banks if there were a default.

All in all, Europe's banks have almost $1.6 trillion exposure to the four countries most susceptible to default in the Eurozone: Portugal, Ireland, Greece and Spain. $727 billion of exposures to Spain, $402 billion to Ireland, $244 billion to Portugal, and $206 billion to Greece.

This builds on the chart I posted at the end of last month, but provides a more in depth view of the goings on.

This is why the EU changed the rules last week for the way it looks at breaches of their rules on debt and deficits, by introducing a “dynamic debt” policy. This policy is based upon debt being allowable above the previous limits, as long as that debt is going down.

So that’s alright then.

Except that the level of debt is meant to be under 60% of GDP and yet, according to the latest economic forecasts by the European Commission, the average level of debt is going to reach 88.5% of overall Eurozone GDP in 2011 and 83.8% for the EU as a whole,

Eurostat figures published in April (12-page PDF) reveal that the highest debt-to-GDP ratios are 115.8% in Italy, 115.1% in Greece, 96.7% in Belgium, 78.3% in Hungary, 77.6% in France, 76.8% in Portugal and 73.2% in Germany. Malta (69.1%), the UK (68.1%), Austria (66.5%), Ireland (64.0%) and the Netherlands (60.9%) came next.

Mind you, this measures only public debt to GDP ratios, e.g. the government’s exposures, and many EU countries are arguing it should cover aggregate debt which would include the private sector borrowing levels. If this were taken into account, then the UK would lead the pack of debtors.

Expect this all to be reviewed and redeveloped under new EU rules announced on 30th June.

What fun!

Europe: broken nations borrowing from broke nations?

After the downgrade of Greece led to the Greek crisis and the Germans worried about bailing them out, the crisis continues with the downgrade of Spain at the end of last week by Fitch.

In fact, it looks like many European countries are worried, with the PIGS now the PIIGS – Portugal, Ireland, Italy, Greece and Spain – whilst Hungary, the Czech Republic, Andorra and Montenegro are so hard up they couldn’t even send their national broadcast channels along to Oslo, to cover the Eurovision song contest over the holiday weekend.

So we asked the question: what happens if the euro fails, and the answer was: a great deal economically, politically and nationally, but not much in banking. The EU creations of SEPA and Chi-X would continue.

But what is the real likelihood of the euro failing?

Not much to be honest.

If it were open to failure, there would be far more concern being demonstrated at this week’s G20 meeting, and the truth is the Americans and Chinese – the other two large regions exposed to the EU – are comfortable with the two-pronger approach being taken by the European Commission and member states.

For example, Reuters reports:

“Early this month G20 governments were clearly worried that some European countries might not be able to summon the political will to confront their public debt problems. U.S. President Barack Obama spoke personally to Spanish Prime Minister Jose Luis Rodriguez Zapatero to urge him to implement budget reforms. G20 officials held conference calls to discuss European policy.

“Since then, Europe has come up with a two-pronged strategy. One prong is a string of national austerity schemes designed to bring state budget deficits and public debt down to safe ratios of gross domestic product in the next few years.

“The most heavily indebted states on the periphery of the euro zone, Greece, Portugal, Spain and Italy, have announced austerity drives this month. Even France, a stronger country, has acted, announcing an intention to enshrine deficit-cutting in its constitution.

“The other prong is emergency liquidity support from rich nations to give time for austerity steps to work; this ensures countries retain access to financing even if they lose the ability to fund themselves in the debt market, as Greece has.

“In addition to a 110 billion euro bailout of Greece, European nations are creating a financial safety net for indebted countries that along with support from the International Monetary Fund could total 750 billion euros -- three-quarters of the total public debt of Greece, Portugal, Ireland and Spain.”

So all is well and good in the garden of Europe.

Or is it?

As mentioned before, Germans are pretty unhappy about the Greek situation.

So I was quite interested when Mike Warner, CEO and founder of Quantum4D – a data visualisation firm – sent me this graphic (doubleclick image to see larger version):

Ouch!

What this clearly demonstrates is that:

Germany thought they owned Greece but they don’t – France do;

The total Greek exposure is €120 billion;

Germany and France have far more exposure to Spain (over €450 billion worth); and

By comparison, Britain is getting off lightly ... about the same levels of exposure as the Dutch.

Who wants to be in the euro, you might ask, but the Estonians still do.

Why?

Why would anyone want to be in the Eurozone today?

Because tomorrow it will be better. It will be a region that is as resilient, strong and powerful as China and America ...

... or is it more to do with this lovely little news skit from our friends in Australia?

This is a comic news report from ABC News’ mirthmakers John Clarke and Bryan Dawes, and is based upon a million dollar gameshow format (in the UK, this is Mastermind).

Here’s my slightly edited transcript:

QUIZMASTER: Your name is Roger yes?

CONTESTANT: Roger.

QUIZMASTER: Good. And what do you do Roger?

CONTESTANT: I'm a financial consultant.

QUIZMASTER: Fair enough. Okay, Roger your special subject tonight is the economies of the European community. Your time starts now. Best of luck.

CONTESTANT: Thank you.

QUIZMASTER: How much does Greece owe, Roger?

CONTESTANT: $367 billion.

QUIZMASTER: Correct. And who do they owe it to?

CONTESTANT: Mostly to the other European economies.

QUIZMASTER: Correct. How much does Ireland owe?

CONTESTANT: $865 billion.

QUIZMASTER: Correct. Who do they owe it to?

CONTESTANT: Other European economies mostly.

QUIZMASTER: Correct. How much does Spain and Italy owe?

CONTESTANT: $1 trillion each.

QUIZMASTER: Correct. Who to?

CONTESTANT: Mainly France, Britain and Germany.

QUIZMASTER: Correct. And how are Germany, France, Britain going Roger?

CONTESTANT: Well they're struggling a bit, aren't they?

QUIZMASTER: Correct. Why?

CONTESTANT: Well ‘cause they've lent all the vast amounts of money to other European economies that can't possibly pay them back.

QUIZMASTER: Correct. So what are they going to do?

CONTESTANT: They're going to have to bail them out.

QUIZMASTER: Correct. Where are they getting the money to do that from, Roger?

CONTESTANT: That is a good question. I don't know the answer to that one.

QUIZMASTER: How much does Portugal owe?

CONTESTANT: Hang on a minute, what was the answer to that earlier question?

QUIZMASTER: Just keep answering the questions Roger. Where is Portugal going to get the money it owes to Germany, if Germany can't get back the money that it lent to Italy?

CONTESTANT: Just a minute. What was the answer to the previous question? The question was: How can broke economies lend money to other broke economies, who haven't got any money because they can't pay back the money the broke economy lent to the other broke economy, and shouldn't have lent it to them in the first place because the broke economy can't pay back?

QUIZMASTER: You are wasting valuable time Roger. How much money does Spain owe to Italy?

CONTESTANT: $41 billion. But where are they going to get it?

QUIZMASTER: Correct. What does Italy owe to Spain?

CONTESTANT: $27 billion but they haven't got it - they're broke.

QUIZMASTER: Correct. How can they pay each other if neither of them has any money?

CONTESTANT: They're going to get a bailout, aren't they?

QUIZMASTER: Correct. And where is the money coming from for the bailout?

CONTESTANT: That is what I'm asking you!

QUIZMASTER: Correct. Why are people selling the European currency and buying the US dollar?

CONTESTANT: Because the US economy is so much stronger than the European economy.

QUIZMASTER: Correct. Why is that Roger?

CONTESTANT: Because it's owned by China.

QUIZMASTER: Correct and very well done! And after that round you've lost $1 million.

CONTESTANT: I've lost $1 million? I thought you said well done!

QUIZMASTER: Yes well done - you've only lost $1 million. That's an extraordinary performance Roger.

Thanks to Philip Brady from Oz for the tip-off re Clarke and Dawes.

When's the next financial crisis and what will cause it?

WARNING: THIS BLOG ENTRY WILL NOT CHEER YOU UP [sorry]

I spent the morning with a group of futurists debating the long-term outlook for financial markets and am never sure about the usefulness of such debates, although there is definitely something of use in creating scenario plans for the future which is where we were focused.

The key question I kept asking myself during the conversation is: when will the next financial crisis take place, what will cause it and is it predictable?

To answer the first part of that question, we only need to look back in history.

If we take the first financial crisis as the fall of the Roman Empire then it was about 1,000 years until the second financial crisis occurred, with the collapse of the Medici banks of Renaissance Italy. Four centuries later, the South Sea Bubble and Great Tulip Collapse took place. 250 years after that, we hit the Great Depression; and 80 years after that we imploded in the Subprime Crisis and Global Credit Crunch.

Sure there were plenty of hiccoughs along the way - LTCM, Asia, Russia and Latin American implosions in the late 1990s for example - but global crashes have been notable.  Loosely speaking, global crisis are now occuring twice as fast as the previous ones:

• 1,000 years – the Roman Empire to the Medicis
• 400 years – the Medicis to the South Sea Bubble
• 250 years – the South Sea Bubble to the Great Depression
• 80 years – the Great Depression to the Subprime Crisis

On that basis, you could bet on the next crisis being anything between thirty and fifty years from now.

2040 to 2060.

So what would cause the next financial crisis? After all, we’re only just trying to get through this one. Surely we can regulate to avoid another one?

Maybe not.

Here’s a view you could take of the factors that contribute to the next financial collapse. I should say that it doesn’t make for fun reading, but the logic could have some grain of accuracy.

2011

Banks globally are heavily regulated, taxed and governed to avoid another subprime crisis. The focus is on derivatives, liquidity, capital and governance.

2012

The European Union struggles through a fragile and fallow period of financial and political instability with Portugal, Italy, Greece and Spain managing to just about maintain Eurozone requirements. Unfortunately, it is at the expense of citizens and governments in many of these nations.  In fact, the cuts and tight budgets in these Southern member states creates a major movement of economic migrants from Southern Europe into Northern Europe, with the associated tensions and fissures appearing between Northern Europe and Southern Europe as a result.

The outcome is that Europe never quite achieves the competitive economic zone it dreamed of becoming.

2016

China opens its markets to full financial servicing, with a rocking stock exchange in Shanghai that becomes the world’s second major investment banking city by volume and value by 2020, just behind New York  This is combined with a revaluation of the Remnimbi (RMB) that satisfies their critics but worries some, particularly the USA, as the Chinese currency is looked towards by the investment community as a possible alternative reserve currency.

2019

Rather than creating a reserve currency for the world, the investment community creates a basket of currencies to avoid too much exposure to risk in one economy – after all, they don’t want a repeat of the 2008 crisis. The basket includes Euro, RMB and Dollar, along with Gold and other commodities. Nevertheless, the decision to place a weighting towards RMB rather than the Dollar creates issues for the USA, which has spent most of the 2010s in stagnation.

2022

The Middle East enters a major crisis, as oil becomes less needed as a commodity due to the rise of alternative energy sources and conversion of many motorised vehicles to electricity. Iran and Israel go to War and there is a huge effort by the United Nations to bring stability to the region. Eventually, Sovereign Wealth from the GCC outflows towards new and rising economies, such as Africa, and tensions continue to rage across the region on an ongoing basis.

2025

Africa’s economy is raging onwards and upwards. Like the BRICs of the 2000s, Goldman Sachs creates a new investment portfolio known as CAGES – Congo, Angola, Guinea, Ethiopia and Sudan – where natural resources of platinum, cobolt, gold, diamonds, manganese, uranium, chromium and tantalite are abundant. Johannesburg is rising fast as one of the largest world financial centres.

China is now the largest trading partner and region with Africa, thank to their investments at the turn of the century. America finds this to be particularly challenging, as their view of Africa had been one of occupation and charity, rather than investment and growth, during this period.

But China doesn’t care too much, as China has now become the world’s largest economy.

2028

American and European investment firms decide to make RMB the reserve currency of the world, and drop the concept of the basket of currencies.

2032

The quiet rise of India as the world’s second largest economy had largely gone unnoticed but, in 2032, for the first time China’s economy had less than 3% growth. This was put down to the lack of skills in the country where skills were needed, and is a reflection of the aging population in China and lack of new blood. China’s one-child policy of the previous century, and a distinct lack of female population for the overly male populated society that resulted, means that 2 in every 5 citizens has reached or is near retirement age. This, combined with strict immigration controls, places a strain on continued growth and industry.

2039

India’s continually booming economy has created frictions between their Chinese border rivals, and a Cold War commences between the two nations. Like the Cold War of the previous century, no arms are traded or battles take place, but the economic controls freeze out much of China from India’s trading partners and vice versa. The result is an economic climate where India’s investment community trade with India and China’s with China.

There are ripples through the Shanghai and Mumbai stock exchanges as a result.

2044

India continues to see success as a stable and harmonised country. China appears to be becoming more unstable as the government struggles to maintain investment and trading, and avoid the inflationary pressures created by their exposure to investments in Africa for future commodities that can no longer be utilised.

The economy fails to achieve growth rates above 1% for three quarters, and the government determines that the Remnimbi needs devaluation. This angers the USA and Europe, who have major investments in Chinese land and other illiquid stocks, along with major reserves of Chinese currency.

The decisions taken by the Chinese government force them to look towards India and Africa.

2050

The outflow of investment by American and European investment houses from China results in aggressive currency arbitrage between the Chinese RMB and the Indian Rupee, with the latter winning as the RMB’s reserve currency status ends.

The resultant big time betting against the continued stability of China causes the Cold War between India and China to spill over into skirmishes.

The world sees a period of major instability ensue and the China Crisis is put down to currency speculation amongst the world’s capital markets created by complex foreign exchange instruments intertwined between the major economies.

Nothing to do with housing this time.

Jeez, that was a depressing vision and I told you this conversation wouldn't cheer you up.

Thank goodness it’s just fiction.

However, if you like this sort of future conjecture and dialogue, you are welcome to join us for two more optimistic discussions (hopefully) at the FSClub in June:

Monday, 07 June 2010
The Long Now of Finance
A panel discussion with Professor Michael Mainelli and guests

This evening is dedicated to a panel discussion focusing upon: "The Long Now of Finance - a Framework for the next 10,000 years".

Many financiers and academics are beginning to focus upon how to invest in long-term projects that secure the planet for our children and grand children and great grandchildren. Short-term thinking is killing the planet. So how do we think long term: the Long Now, and how do we fund it: Long Finance?

Long Finance is an initiative begun in 2007 by Z/Yen Group in conjunction with Gresham College, to establish a World Centre of thinking on Long-Term Finance. The initiative began with a conundrum – “when would we know our financial system is working?” and has worked on a variety of projects, including the signature program focused upon an Eternal Currency.

This debate will be chaired by Professor Michael Mainelli, a cofounder of Long Finance and Executive Chairman, Z/Yen Group.

Monday, 14 June 2010
The Future of Banking, a discussion with Professor Ray Barrell, Professor David De-Meza and Professor Donald MacKenzie of the Economic and Social Research Council, chaired by Brian Caplen, editor of the Banker Magazine.

The Economic and Social Research Council (ESRC) is the UK's leading agency for research funding and training in economic and social sciences. Established in 1965 as the Social Science Research Council, under a Royal Charter, the ESRC covers a wide range of disciplines, ranging from anthropology to statistics with a budget that has grown from £73 million in 2001-02 to £204 million in 2009-10. Financial services are a key sector for the Council's business engagement strategy. The ESRC is partnering with the Technology Strategy Board on the new Financial Services Knowledge Transfer Network. This evening the ESRC has kindly agreed to host a discussion focused upon the Future of Banking featuring three very distinguished scholars.

Professor David De-Meza is with the London School of Economics and has published many papers on banks policies in a wide range of journals. He is the on the Council of the Royal Economic Society and the Institute of Economic Affairs; Associate Editor of the Journal of Industrial Economics and Joint Managing Editor of the Economic Journal.

Professor Donald MacKenzie is a Professor of Sociology at the University of Edinburgh, with work that has constituted a crucial contribution to the field of Social Studies of Finance. He has also undertaken widely-cited work on the history of statistics, eugenics, nuclear weapons, computing and finance, and was awarded the Chancellor's Award from HRH Prince Philip, Duke of Edinburgh and Chancellor of the University of Edinburgh, in August 2006 for his contributions to the field of Science and Technology Studies.

Professor Ray Barrell is a visiting professor at Brunel University, Director of Macroeconomic research and Forecasting for the UK and World Economies, and Senior Research Fellow at the National Institute of Economic and Social Research. Previously, he has been a visiting Professor of Economics, Imperial College, London from 1996 to 2004, and was a part-time professor at the European University Institute, Florence, 1998-1999. He is on the editorial boards of Economic Modelling and was on the board of the Journal of Common Market Studies until 2007.

The credit rating agent's thumb

I dropped into the offices of one of the credit rating agencies this week. The one that caused confidence in Greece to fall through the floor: Standard & Poors.

The agencies are interesting places at the moment as many attributed the AAA-rated toxic mortgage derivatives to their watch, so now they’re being cleaner than clean and holier than thou. Or that’s my take on this.

That’s why S&P came out with a negative rating on Greece just when Greece needed a cheerleader. Downgrading their sovereign wealth to junk bond status at the end of April, just at the point where sensitive bailout terms were being agreed, created the meltdown in the euro. Equally, I suspect they’ll do the same for Spanish bonds next, followed by Portuguese and Italian debt later.

The fear is that this could create a contagion effect, with Europe on the point of fragmentation and the end of the euro in sight. Hedge funds are betting big time against the euro and Angela Merkel and Nicolas Sarkozy are fighting for the future of the Union.

With all of the repercussions, it makes you realise the power the rating agencies now wield. They are almost being looked at as the Credit Rating Caesar of today in the Colisseum of Investments where the Hedge Fund Lions surround the Sovereign Debt Christians for a good Short Selling Gladiatorial meal.

Will the Credit Rating Caesar raise his thumb skyward or to the ground?

Will the Hedge Fund Lions attack or be held back to allow the Sovereign Debt Christians to fight another day?

I hear that our European leaders are calling their national regulators to call their credit rating contacts to plead for the thumb to be raised skyward.

We shall wait and see.

In the meantime, it gave me a chance to pop in and pick up a copy of S&P’s excellent weekly publication Credit Week, and guess what? Page 38 explains and defends the reasons for the Greek downgrade in a one-page article by David T. Beers.

It makes for fascinating reading, particularly in light of the fact that the credit rating agencies will come under a new EU regulatory mandate from 1st January 2011.

Will Barnier outlaw credit rating agencies from doing another Greek downgrade in the future? I wonder.

Specifically, is it agreeable for the ECB to hold ‘junk’ bonds ... they do now, as they’re backing the Greek funding crisis.

Anyways, here’s what S&P has to say about it:

Standard & Poor's Ratings Services' recent decision to lower its sovereign rating on Greece has drawn various comments: some supportive, some suggesting it is either too little too late, or too much too soon. It is a debate that highlights the very different responses that our rating opinions can sometimes elicit--and the need for us to reiterate the reasons for our actions and our broader role in the market.

First and foremost, we recognize that our views are sometimes unwelcome to the issuers we rate--and in this case to EU officials--but we believe our focus has to remain firmly on serving investors.

This is clearly a difficult time for the Greek government, the Greek people, and for the Eurozone as a whole. But as an independent provider of credit research and opinions, our primary duty to investors is clear: we have to communicate our view about relative credit risk as we see it, without fear or favor.

Greece is a good example of this principle in action. Our recent decision to lower its sovereign rating to 'BB+' was prompted by downward revisions to our economic growth assumptions for the country. In our view, the size and scope of the fiscal retrenchment required to stabilize Greece's debt burden are likely to further depress Greece's medium-term growth prospects. Under our new assumptions, we do not expect nominal GDP to regain its 2008 level until 2017.

At the same time, like many others, we see the Greek government facing a growing challenge to implement its fiscal reform program. We now estimate that stabilizing the government debt burden implies a reduction in the primary fiscal deficit (excluding interest payments) in the order of 13% of GDP-?a tough target compared with what other sovereigns have been able to achieve in the past.

In short, Greece's longer term fiscal prospects have led us to conclude that the sovereign's creditworthiness is no longer compatible with an investment-grade rating.

Some have suggested we should have suspended judgment until the EU/IMF bailout was finalized. We think not. We have repeatedly pointed out that a bailout, while addressing Greece's near-term liquidity problems, does not necessarily secure its longer term solvency-?as examples of sovereign bailouts in other parts of the world have shown.

In our view, Greece should be able to roll over its maturing debt for the remainder of 2010, as a result of the official financial support it is receiving-?and which we have repeatedly said would be forthcoming. But our reservations about Greece's credit standing are focused on the political and economic challenges its government is likely to face over the next three to five years?-challenges that, in our opinion, the bailout cannot easily resolve.

A faster return to fiscal balance may, in time, help market confidence recover and lead to an improvement in the sovereign rating on Greece. However, in our view, the success of this strategy ultimately rests on one factor the Eurozone authorities and the IMF can try to influence but cannot control--the willingness of the Greek people to embrace fiscal austerity on a scale never before attempted in the country. And that willingness is only now being tested.

As our 'BB+' rating implies, we do not see Greece in imminent danger of default (the historic 10-year default rate of 'BB+' rated sovereigns is 14%), but we do see increasing risks to its credit standing over the longer term.

Some have suggested that our ratings have been driven simply by market sentiment. In fact, as our record on Greece shows, the contrary is true. For much of the last 10 years, until the financial crisis, the market valued Greek debt nearly on a par with 'AAA' rated sovereigns like Germany and France. Yet our first downgrade was in 2004, when we lowered the rating on Greece to 'A' from 'A+'. For over a decade, in fact, our views on Greece's credit standing were contrary to the market consensus.

During the past year, investor sentiment has clearly swung in the opposite direction, but we have continued to take a more balanced view of Greece's creditworthiness. That remains the case today, even after our recent downgrade.

There is little evidence, in other words, that we are driven by the market. The reality is that we provide an independent view that investors may or may not choose to consider. Ratings are one of many inputs that investors look at, and they are only one of many factors that may affect movements in the market. While credit markets regularly overshoot and undershoot depending on the ebb and flow of sentiment, ratings take a longer term view of fundamental credit risk and tend to steer a middle course.

The market benefits from competing views on credit risk, whether from ratings firms or others. Currently, for instance, it is digesting three different ratings on Greece from the three major credit ratings firms. We welcome this debate and are committed to contributing to it by providing our independent view. We do so on the basis of rigorous research, local knowledge, criteria that we apply consistently worldwide, and transparency about our rationale and assumptions, which enables investors to take an informed rather than uneducated view of our ratings.

This principle of independence is a crucial one. It is enshrined in the EU legislation governing ratings firms, which comes into effect in September. This regime introduces day-to-day oversight of ratings firms' activities by EU securities regulators and is expressly designed to promote the independence and integrity of ratings?-in particular, to ensure they are not unduly influenced by debt issuers or other external parties. We strongly agree with this principle and believe that our recent rating decisions on Greece, and other EU sovereigns, demonstrates its application in action.

What happens to SEPA, Chi-x etc if the euro fails?

There’s the classic old joke about the European dream being a place where the police are English, the chefs are Italian, the car mechanics are German, the lovers are French and the bankers are all Swiss. The nightmare is that it is a place where the police are German, the chefs are English, the car mechanics are French, the lovers are Swiss and the bankers are Italians.

It seems that the nightmare is coming true, although the basket case is Greece and the bankers are German.

Last week’s surprising comments from German Chancellor Angela Merkel that “the euro is in danger” and “if the euro fails, Europe fails” sent shudders across the world’s markets, and probably made Brussels shake with rage.

But the Germans are shaking with rage. After Nicolas Sarkozy was rumoured to threaten Merkel with France’s withdrawal from the euro if she didn’t step up to the plate and support a Greek bailout, Germany’s citizens have been demonstrating their rage by printing deutsche marks whilst the national newspaper, Bild, is stirring anger towards the EU and the Greeks in particular with headlines such as:

• "How much more do we have to pump into this country?" April 26th
• "Why are we paying the luxury pensions of the Greeks?" April 27th
• "Greeks ready to cut back? They would rather strike!" April 28th

As I talk to German colleagues, they refer to Greece as the Golden Fleece and that they aren’t paying bills in Greek restaurants because they’ve prepaid to 2020.

All of this puts a huge strain on the European Union, in its fragile 53rd year of unity, particularly as Spain, Italy and Portugal are considered to be on a par with Greece by many, forming a Southern European Union called the PIGS [Portugal, Italy, Greece and Spain].

It raises a key question in my mind, and I’m sure all of the bankers I deal with: if the euro fails, what happens to the monetary union of banks, the Financial Services Action Plan and all those bank and insurance directives like Solvency II, MiFID and the PSD?

What happens to Chi-X, SEPA, the EBA and the rest?

In order to answer this question, you have to look at two key areas. First, is the economic and monetary union (EMU) broken? Second, if it is, do we throw away the eighteen years of change introduced by the agreement to launch the euro when the Maastricht Treaty was signed in February 1992?

Let’s take the first question: is the EMU broken?

We asked this question in 2005, when the French and Dutch threw out the EU Treaty. Answer: it is political union that they were rejecting, not economic union. Note: even with their rejection, and the Irish no vote, the Treaty became the Lisbon Treaty in 2010 regardless of such resistance. In other words, in the interests of the long-term vision of Europe, Europe wins.

Equally, America has taken years to gain its United status, starting with a nation of disparate states that had far less history than those of Europe.  Their Union was easier in comparison, and that still took years, so Europe’s union will take time and will face many more tests.

But this is the greatest test so far.

The size of this test should not be underestimated as it is the first time that we are seeing an economic union, resulting in a cascading effect upon money and politics. Historically, the tests for Europe have been mainly about how much power is ceded to Brussels. This test is showing the inter-relationship between economies and Germany’s anguish is that if they are to keep the vision of Europe in harmony, then they have to pay for it.

Therefore, returning to the rejection of the European constitution, that was a political rejection and when a country has an economic crisis, the monetary union means that other nations pay and, as a result, that political will is tested when one nation's tax dollars are taken to pay for another nation's debts.

That is why this challenge is so much greater than any before, because it is testing the political will of citizens, not just their ability to trade and compete.

The core issue though, is that it is not just the Greek economy and Greece that would leave the Union if they were allowed to fail.  It is the Union.

Should the Greek economy fail to honour their government bonds due to being economically bankrupt, the ratings agencies and banks would downgrade Spain, Portugal and Italy, and there would be a spiral effect. This means the European Union breaks apart.

That is why the Greek failure option is unpalatable ... but is the alternative palatable?

Why do we need a European Union?

Answer: Europe needs to be a Union to maintain its drive to be a regional superpower, and competitive commercially and economically with China and America. There’s the rub. If Europe fails, then the UK, Germany and France fail, as parity to compete internationally and intraregion becomes far more difficult.

This is why Greece needs the bailout and why Germans are paying.

It does not help Angela Merkel maintain her status or power hold in Germany – her popularity is sinking faster than the Titanic – but if Greece fails, it is felt that Europe may fail too. And that is not an option seen to be agreeable today.

Also, nations have been bailed out already.

Two years ago, Spanish banks received over €50 billion worth of ‘aid’, in the form of mortgage-backed securities with the European Central Bank (ECB), when they faced a property meltdown.

Did the Germans wail out about that bail out?

No.

Why?

Because it wasn’t on the front page of the Bild.

That bail out was smaller and less obvious, so no-one really noticed.

The Greek bailout is a bit bigger – €110 billion – admittedly, but it is supported by the IMF and is necessary for Europe’s future. ‘nuff said, although if you want to know more, Robert J Samuelson in the Washington Post provides a particularly good overview of why Europe needs to support Greece.

My summation is that Europe will survive this crisis, the euro will stay and the currently ridiculous pricing of US$1.24 to the euro will reverse within the next month or so, as forecasted by most economists.

But let’s look at the worst case scenario: what do we do if the euro does fail? Does it mean we unravel all we’ve done to date?

This is the second and, in some ways, more important question: is there a backup plan?

OK, if the Eurozone breaks apart, then it matters ... but it will not throw away all that has been built to date.

The banks will still want to use cross-border instruments that work. They will just bring back a margin to represent those cross-border movements whilst maintaining the efficiency of the infrastructure that has been built.

As Werner Steinmuller, Head of Global Transaction Services of Deutsche Bank, stated when we researched the Payment Services Directive (PSD) and the Single Euro Payments Area (SEPA) last year:

Deutsche Bank is in a comfortable situation. We spent quite a sizable amount on SEPA infrastructure and have a brand new system that is extremely capable of doing this that is also highly scalable. Others have not made this investment so this gives us a price advantage. We have built some conversion solutions for handling old volumes and now can run both old instruments and the new SEPA instruments so, if SEPA is coming, we are extremely well positioned. If SEPA fails, I can write off the investments and still win.

In other words, the SEPA process has forced the banks to build new infrastructure, new systems and new efficiencies in transaction processing. That will stay.  It does not go away if the euro goes away, as the new infrastructure is designed to handle efficient transactions, not euro payments.

So if we look at SEPA Credit Transfers and Direct Debits, the Euro Banking Association (EBA) and STEP2 ... it will all stay. The EBA will be a private consortium to operate efficient systems, rather than a government initiative to create efficiency, and it will stay. There will be a charge for this, and a charge that could provide a substantial return to the banks that created this infrastructure, but it will not go away.

The same will be true for Chi-X, and the capabilities electronic trading platforms have introduced into the European equities markets. Sure, some countries may want to block and reverse policies in these areas – Spain? – but the process of regional investing is unstoppable now. Goldmans, Merrill, BarCap and co, won’t want to see this go away, so it will remain.

Bottom-line: the efficiency of European payments and investing is in the interest of banks, corporates and institutions today, not just governments and policymakers.

So, if the euro fails, my answer is that the all the investment made by the financial markets in efficient systems will stay.

It will just be at a profit rather than a regulation.

The euro is in danger

After Angela Merkel's comments about the "euro is in danger", I was going to write a long and in-depth review of the state of the euro ... but I was beaten to it by Chris Blackhurst's column in the evening standard.

Rather than reinvent the wheel, just read what he has to say:

"Merkel was only saying in public what other EU governments and their advisers have been saying in private for weeks. Greece, with its rioters to the fore, could literally go up in flames and no amount of injection from the other euro countries may be enough to save it ... and after Greece come Portugal and Italy and Spain."

Totally agree, although I don't agree that the euro's day has come.

Will blog about that shortly. For now, his column is worth a read.

 

 

So not PC but ...

This is so politically incorrect that I almost didn't post it ... but then I did to show how cultures are different and sensitivities are not the same.

As I left Singapore, I saw this and felt quite offended:

Yet Singaporeans are desperate to avoid offending foreign visitors, as are most Asian countries, so how could I be offended?

Well, look more closely ...

I'm sure that my Western colleagues will get the point.

No wonder, following on from Damian Glendinning's points raised earlier, that we don't always agree:

• SAMBO (Singapore): a building company
• SAMBO (UK and USA): a racial slur

But then we arrive in Asia and handout business cards with one hand and immediately put a received business card in our pocket without reading it. 

In Asia, the protocol is that we should offer the business card to the receiver as a gift, with the upper top corners held in each hand so that the card is presented the right way round to be readable.  Similarly we should take their card with honour, and read the details of title properly before putting the card away.

These nuances of societies are brilliantly described in Richard Lewis's book, When Culture Collide, and have been used in HSBC's advertising to great effect for the past eight years.

It was 2002 when this ad first aired ...

... and it's true.

When global, think local, so I wasn't offended after all, as the meaning of the word is not intended.

Now, who was it called me ****** just now?

Want to know the latest on SEPA?

If you're wondering what's happening with SEPA (the Single Euro Payments Area) then this interview with Gilbert Lichter, Secretary General of the Euro Banking Association (EBA) and CEO of EBA Clearing, provides a good overview of the latest and greatest:

Gilbert Lichter from Chris Skinner on Vimeo.

The interview took place after our recent FSClub meeting with Gilbert.

Spanish Banks leading in innovation - now the iPad Bank (UPDATE)

It surprises me how often I find Spanish banks surprise me.

First, BBVA launch the first really cool Bank 2.0 apps two years ago.

Then Caja Navarra launches a fantastic hybrid Zopa-Bank styled P2P lending service.

More recently, Santander created a really interesting head office campus full of robots.

And now Banco Sabadell is one of the first, if not the first bank to launch an iPad banking service.

My good friend Pol Navarro, Director for Innovation at Banco Sabadell, tells me that they decided to do this because: “since we launched our mobile portal, at the end of 2009, we've seen a tremendous usage from iPhone users - about 60% of access - so we decided to develop a specific app for the iPhone/iPad.”

Certainly, that seems to be indicative of a core focus upon the customer as, in just three months since its launch, Banco Sabadell’s Mobile Service (BSMS) is being used by more than 13,500 customers of the bank and is expected to exceed their target of 35,000 customers this year.*

According to the bank’s blog – yes, they have a blog! – the “new version of BS Mobile for iPhone IPAD and includes all operations currently available in the BS Mobile service (consulting accounts and cards, transfers and transfers, purchase / sale of securities, signature files, etc. ..) for both the segment private customers and companies, taking advantage of new capabilities for interaction and usability that Apple devices offer and improving current features:

Tracking all current procedures of the customer (card applications, loans, etc ...) to give the best customer service and information wherever you are.

• Higher quality maps and greater precision in the location of offices and ATMs, as well as Street View.
• New presentation of the application, Touch and more intuitive.
• Ability to save favourite operations and menu customization operations.
• Keyboard shortcuts to the operations of accounts, cards, data transfers and your personal manager.
• Option to call me back for easy access to the Contact Center.”

UPDATE: New and improved video

In addition, Pol tells me that they “think that the iPad has its own space, for consuming digital content online/offline (airplanes, garden, home, etc.) ... the iPad version, has some specific functions, adapted to the terminal’s screen size, user interaction, maps navigation, etc.”

They are also developing the iPad further: “for example, product simulation of loans and mortgages, investment portfolios, video calls with your sales rep, etc. Also this kind of gadget can be used internally, for sales rep, private banking advisors, etc. We are just investigating in this side.”

All in all, Spanish banks never fail to impress me with their first mover experiments in social and mobile finance.

Definitely not a case of mañana my friend.

* Banco Sabadell has €82 billion in assets with 1,190 domestic branches and 9,466 staff

Why the G20 will disagree with the IMF reforms

I don’t know if any of you read the IMF report recommending two new bank taxes:

• a bank levy based upon the risk banks represent, called a Financial Stability Contribution (FSC); and
• a straight tax on profits and bonuses called the Financial Activities Tax (FAT).

If you haven't, then I can recommend it's worth a skim.  For example, they reject the Tobin Tax / Robin Hood Tax idea, saying that this would just get passed on to customers by the banks. 

However, the fact that they support the idea of a levy and a tax – a double whammy – could have bankers worried ... except that bankers are pretty clever at tax avoidance and Canada and Japan have said they won’t implement these plans so it’s a G18 agreement right now, or less.

In my view, the document is also flawed.  Here's why.

The document itself is just for discussion for the G20 Ministers meeting this week, with the aim of agreeing something in June.  It was leaked by Robert Peston over at the BBC, and has created a fair bit of mileage for him with two blog entries: IMF wants two big new taxes on banks and How much would IMF bank taxes raise?

Robert's estimate for the latter is about £5 - £10 billion ($7.5 to $15 billion) per annum.

The leak has also sparked a whole range of other headlines, including:

Leaked IMF document urges two new taxes for banks - The Times
IMF recommends double tax whammy on the world's banks - The Independent
IMF urges double tax hit on banks to refund taxpayers - The Telegraph
IMF warns over sovereign debt - The Independent
Post-crisis banks must refinance $5 trillion - The Times

And here’s the document itself (Download IMF G20 Document, 57 page pdf).

All well and good.

Now the actual content is debatable and not set in stone.

As I said, it’s for discussion.

But it does contain some really interesting appendices which are noteworthy as useful research materials, covering diverse subjects from each country’s proposals for reform to their contributions to the bank crisis to date.

For example, here are the amounts announced or pledged for financial sector support so far, as a percentage of 2009’s GDP (doube-click chart to see a bigger version):

What this shows is that for the ‘advanced economies’ – think USA, UK, France, Germany, Japan et al – the cost has been 6.2% of GDP in direct support and a further 10.9% in guarantees.

The total of columns A to E represents 29.8% of advanced economies’ GDP in 2009.

That compares with 1.8% in the emerging economies – think the BRICs, Indonesia, et al. 

Mind you, they then go on to say that “for the advanced G-20 economies, the average amount utilized for capital injection was 2 percent of GDP, that is $639 billion, or just over half the pledged amounts. France, Germany, the USA and the UK accounted for over 90 percent of this. For the advanced G-20 economies, the utilized amount for asset purchases was around 1.4 percent of GDP, less than two-thirds of the pledged amount. Similarly, the uptake of guarantees has been markedly less than pledged.”

This is why the report reckons that the global financial crisis has cost about $533 billion less than originally estimated, and is now just a mere $2.28 trillion when all is said and done.

Now how much is $1 trillion again?

Thanks Mint.

So yes it’s still a lot, but it’s half a trillion dollars less than before.

Phew!

Now who’s the daddy when it comes to global bailouts and guarantees:

Wow, the UK wins!

We’re number one, we’re number one, we’re number wohohohohone.

Wait a minute.

That means we’re #1 in global bailouts of banks.

Hmmm ... not sure if we should be so thrilled with that accolade and maybe this is why Gordon Brown is so keen on the idea of a Tobin Tax or a Robin Hood Tax or a Financial Activities Tax or ... well, any tax really to help with our debt mountain to be honest ...

Source: the Daily Mail

... as the burden of national debt amongst the G7 nations is at a 60-year high, with the UK’s Treasury planning to increase national debt by over £560 billion between now and 2015. That’s about $800 billion or almost a trillion (how much is a trillion again?).

Meanwhile, the emerging economies paint a very different picture:

Apart from Russia, this crisis has cost the key future economies of the world urrmmmm ... nothing.

These charts make it clear that NINE of the G20 nations have had no crisis. Add to this the fact that Canada’s financial system has been the most stable in the world, and Japan do not intend to implement these tax and levy options, and you realise that under half of the G20 will be keen to support any radical changes to the financial markets.

It's not as clear cut as this, as the fact that the Advanced Economies bailouts allowed the Emerging Economies to survive this crisis without their economies also imploding is a key part of the dialogue.

Another useful chart shows why the IMF has reduced the bailout numbers by $533 billion where financial markets have used far less of the pledged amounts than those offered by their respective governments:

Finally, these charts are followed by a review of each country’s bank taxation policies implemented or proposed (Appendix 2, Page 32), a review of corrective taxation and prudential policies (Appendix 3) and the current taxation policies (Appendix 4).

This last section is also particularly intriguing as it demonstrates why banking has been so critical to Gordon Brown’s policies of the past decade. For example, here’s the percentage of a country’s total tax pool raised from financial firms by country.

G20 Corporate Taxes Paid by the Financial Sector (in percent)

This makes it clear that for every country, but particularly for Italy, Turkey, Canada and the UK, the role and influence of the financial sectors on their economies and government policies is fundamental to the country and its economic and public sector health.

Without bank taxes, countries fail.

But with bank failures, countries fail.

And that is their Catch-22 and the reason why this is so hard to change.

Between domestic interests and focus, aligned with the radically different ways in which this crisis has impacted each G20 nation, it is unlikely that we shall ever see a simple agreement of policy reform now, or at the G20 meeting in Toronto in June.

UPDATE: 23rd April 07:50

Looks like the head of the IMF agrees with me:

IMF Says Financial Revamps Could Thwart Global Deal

The International Monetary Fund's managing director said he worried that rivalries among countries could thwart a global overhaul of financial regulation, as governments split over the merits of an IMF proposal to levy a new tax on the world's banks.

"The risk…is that different parts of the world will have their proposals which make sense" to them, but "which may be somewhat inconsistent," Dominque Strauss-Kahn said at a press briefing ahead of this week's meetings of financial officials from around the world.

Santander: confused, boring ... or innovative?

Thanks to Andrew Carrier's tweet for spotting this brilliant story in Gizmodo about Grupo Santander's Head Office in Santander City, Spain.

Gizmodo liked the fact they have wee little robots running around guiding visitors around their massive HQ.

Their HQ “is so damn big and confusing to navigate that you'll desperately need these multilingual robots to guide you around ... you stroll up to where the mechanical swarm is waiting, tip-tap your way through a menu on a robot's touchscreen to select your preferred language, pick a destination, and off you go.

“The robots are about knee-high and zip back and forth through the Santander Group's financial complex in Madrid. They're clever enough to avoid running into people, other robots, or any of the LED panel covered columns around the complex while promptly getting you to your destination.”

It makes sense, as the bank moved its Central Services from Madrid to the new headquarters, Santander City, in April 2004 and 6,800 people work there today, so it is a big campus.

However, although Gizmodo may like it, TIME Magazine labels Santander “the most boring bank in the world”:

“Banco Santander's no-nonsense headquarters sprawls across a dusty hilltop a little over 12 miles (20 km) from downtown Madrid. But it seems a world removed from Spain's capital, with its long naps and midnight dinners. Santander City's squat, red-brick bunkers don't try to make any lofty architectural statements, and its workers would be too busy to notice even if they did. Travel between buildings is underground on white shuttle buses. Cigarette breaks don't last long; the leafy inner courtyards have no place to sit. ‘This is a place to work’, says a spokesman wearing the standard-issue Santander red tie.”

The TIME article goes on to explain why Banco Santander's has risen from being the sixth biggest bank in Spain to the largest bank in the Eurozone in just a quarter of a century thanks to the leadership of Emilio Botín, who took over the bank from his dad back in 1986.

Well worth a read, even if half the workers these days are robots.

p.s. please invite me over to visit :)