Archive for the ‘Banking’ Category

In yesterday’s ‘FT’, it was suggested that the US Federal Reserve is considering forcing US banks to operate much higher capital ratios. The idea is to reduce the risk of a banking crisis. Critics say such action may increase the risk of prolonged economic downturn.

It all boils down the perceived riskiness of different assets. A bank with lots of high risk debt on its balance sheet needs more capital under Basel III rules. A bank with low risk debt, such as US government bonds, does not need so much. The Fed is looking at changing this.

The ‘FT’ put it this way: “The move is being considered amid growing scepticism about the Basel III capital accords, which impose higher capital requirements on banks around the world but allow them to vary the amount depending on the riskiness of individual assets. Officials are concerned that some banks are gaming the system.”

But, and this is the more interesting point, the ‘FT’ also said: “However, critics of a higher leverage ratio argue that it is a blunt tool that makes no distinction between safe securities, such as US Treasuries, and risky assets such as leveraged loans, and could result in banks taking on more risk.”  See: Fed weighs tighter cap on bank leverage 

So there you have it, the Fed tries to reduce risk, and in the process may be creating more risk.

But then again, is that not the point? Regulators do have this problem seeing beyond the end of their nose. They try to reduce risk, for example by enforcing higher capital rules, and in the process risk prolonging the recession, which in turn leads to bank losses, and may force banks to impose even higher capital reserves.

Isn’t the whole point of QE to try to urge investors and banks to take more risk; to buy more risky assets?

The big error of the growth years was to see mortgage security as low risk, when in fact applied out across the economy it was high risk.

The truth is that the creation of wealth relies on risk. The more risky loans banks make to innovators, the less risk of a major economic crisis.

If changes to bank capital rules mean banks take on more risk, in the sense that they back innovation, then that should be applauded and so should the Fed.

© Investment & Business News 2013

The Bank of England has made tweaks to its funding for lending scheme – all told they seem to be encouraging, but is there a catch?

Firstly, the UK’s Central Bank has extended the window of its funding for lending to 2015.

Secondly, it has made changes so that banks can use the monies made available under the scheme to lend to financial leasing and factoring companies. In short, the Bank of England is encouraging lending to companies that provide financial support to other companies.

Also – and this took most by surprise – banks will be able to acquire £5 of cheap lending from the Bank of England for every £1 they lend to SMEs (that’s firms turning over less than £25 million). In other words the Bank of England is saying: “I will lend you a fiver at a really low interest rates and really good terms, if you lend £1 to Sid and Tom, and Jack, and indeed Joan. An even more generous scheme is available for banks which lend in the next few months.

The big snag with all this is that many banks are still undercapitalised, and no matter how much cheap money is waiting for them in loans they can’t make these loans unless they have more capital. And the way to get more capital into banks is for them to make more profits, which are then largely retained in the business, which may mean they need to engage in more investment banks paying huge bonuses. Either that or they simply need to reduce lending altogether.

However, changes to the funding for lending scheme also allow scope for banks to lend more money to buy-to-let investors.

The Bank of England does not get it.

SMEs don’t necessarily need more debt. And banks dare not make too many loans to business, because these are inherently risky. Buy-to-let, however, is seen as less risky. A rise in buy-to-let activity may lead to a rise in house prices, which may increase the amount of collateral available as security against bank loans to businesses.
But that is not what the UK needs. It needs lower house prices.

As for business, it doesn’t need more debt. It needs more investment in the form of equity; more venture capital and business angels; more investors sharing in profits, rather than making money from an interest rate on loans provided.

If the funding for lending scheme was to revolutionise the lending to VC and business angel networks, that would be a different matter entirely.

Where were you? Where were you when you heard about the death of Diana? Where were you when you heard about the release of Mandela? If you are more advanced in years, where were you when Kennedy was assassinated? There are certain things we never forget. If you are Cypriot, here is another question of that ilk. Where were you when you heard about plans to force all depositors in Cypriot banks to pay a levy to meet the costs of bailing out the economy?

Okay, the plan got revised to something not quite as unpleasant, but still pretty awful. All that happened three weeks or so ago now. Cyprus was left reeling, but its bad luck got largely forgotten by the media, and all that was left was a nasty taste, and renewed fears that the Eurozone is on a one way route to somewhere not very pleasant.

The European Commission did not forget, however. Its economists sat down and got on with the important task of revising their projections for Cypriot growth. Then the penny dropped. Because Cyprus has to contribute seven billion euros to its 17 billion euro bail-out, the economy will suffer. It revised projections for 2013 growth downwards from minus 3.5 to minus 8.8 per cent, and 2014 growth from minus 1.3 per cent to minus 3.9 per cent. These are nasty numbers – although some economists reckon its forecasts are too optimistic. Alas, if Cypriot GDP is going to be lower than previously expected, it will need a bigger bail-out. In fact the commission has worked out that Cyprus now needs six billion more than was previously thought, or 23 billion euros.

The European Stability Mechanism (ESM) and IMF had already agreed to contribute 10 billion euros to the original bail-out. Would they add to their funding? Errr no: they are staying put.

So that means Cyprus has to raise 13 billion euros, instead of the seven it was originally required to raise.

Do you see where this is going? If Cyprus has had so much difficulty working out how it will lay its hands on seven billion euros, and the resulting costs will cause GDP to slump even more than previously feared, how on earth is it going to rustle up 13 billion euros? And then what effect will that have on the economy, and how much will GDP contract as a result, and how much more money will Cyprus have to raise, and how much will GDP then contract as a result, and how much money will Cyprus then have to raise, and now much will GDP contract as a result, and then how much more money will Cyprus have to raise and…(shame the author is not being paid by the word, this example could carry on forever).

©2013 Investment and Business News.

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Do you remember when Gordon Brown sold much of the UK’s gold reserves? Not a good move that, since the yellow metal soared in price soon afterwards.

Then again, back then gold was not fashionable. Keynes called it a barbarous relic, and for a while during the noughties, that description seemed about right. Could Brown have known how much things were going to change?

They did change, and gold became many investors’ best friend.

The thing about gold is psychology. You can’t do much with it, other than look pretty when you wear it – although it is a good semi-conductor. But because of gold’s history, and its presence in our psyche, it is seen as safe, really safe, safer than houses, as safe in fact as gold.

But the yellow metal has not being doing as well of late. Back in the summer of 2011 it was trading at about $1,900 a troy ounce, now it is down to around $1,560.

Maybe it is not so safe.

In recent years, the price of gold has been correlated with expectations of US QE. It was seen as a hedge against the dollar as much as anything. The Fed is not so QE friendly these days. The latest minutes revealed that many Fed members felt QE needs to slow down.

But consider this point of view. If gold can’t do much, in times of really big trouble when we need money, why hold on to it?

The combination of austerity, lack of QE and sovereign debts in the Eurozone is combining to tempt many countries to sell their gold.

Cyprus is selling 400 million euros worth. It needs the cash, for obvious reasons. For almost as obvious reasons, it may have timed the sell-off perfectly.

Will other countries follow suit? Is gold going back to being a barbarous relic?

©2013 Investment and Business News.

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Who needs central bankers anyway? It’s a view often expressed by the more adamant supporters of the markets.

This is what Nassim Taleb had to say on this very matter in his book ‘Anti Fragile’: “Ask a US citizen if some semi-anti governmental agency with a great deal of independence (and no interference from Congress) should control the price of cars, morning newspapers and Malbec wine….He would jump in anger as it appears to violate every principle the country stands for, and call you a communist post-Soviet mole for even suggesting it. Then ask him if the same government agency should control foreign exchange, mainly the rate of the dollar against the euro and the Mongolian tugrit. Same reaction: this is not France.

Then very gently point out to him the Federal Reserve bank of the US is in the business of controlling and managing the price of another good , another price called the lending rate, the interest rate in the economy (and has proved to be good at it). The libertarian presidential candidate Ron Paul was called a crank for suggesting the abolition of the Federal Reserve or even restricting its role. But he would he also have been called a crank for suggesting the creation of the agency to control other prices.”

Losing candidate for Vice President at last year’s US election Paul Ryan is also an arch critic of central banks, and about as anti QE as you can get.

Now enter stage right a new currency. It’s called the Bitcoin, and was launched in 2009 by a developer with the pseudonym Satoshi Nakamoto. It’s a virtual coin, existing solely on the Internet. You can buy goods and services in Bitcoins, and your store of Bitcoin wealth exists in a kind of virtual wallet.

Although the Bitcoin may not have been designed specifically for this purpose, it is often used to purchase illegal goods.

The supply of Bitcoins – if you like the money supply – is controlled by algorithms. There is no central bank; instead a peer to peer network controls this currency via the forces of the market. At the beginning of this month the monetary base was said to be around $1 billion.
So this is an experiment in libertarian economics. Will this new fiat currency replace those that are artificially controlled by central banks?

There is a snag. And the snag comes in the guise of a bubble. The price of a Bitcoin – or if you like, its exchange rate – has doubled in two weeks and, according to the ‘FT’, the monetary base is now worth $1.5 billion.

UBS stockbroker Art Cashin said in a note to clients: “Trading tulips in real time…It is rare that we get to see a bubble-like phenomenon trade tick for tick, but all that may be changing before our very eyes.”

The Cypriot crisis has not helped, with the currency’s supporters describing it as an alternative to conventional currencies.
But is the rate at which is value is soaring sustainable? Probably not. Is it a bubble: probably.

But the question is: does it matter?

In a world of no central banks, and currencies that are solely controlled by markets, failure is essential for correcting errors and for punishing over-exuberance. According to libertarian economics, market forces ensure recessions are only ever short lived affairs.

But are the libertarians right? Perhaps they are, but just remember that in nature – that ultimate example of a free market – growth is not automatic; change often only occurs after some kind of natural disaster, and sometimes evolution can throw up inefficient quirks such as peacocks, whose colourful appearance makes the male attractive to potential mates, but easy prey.

©2013 Investment and Business News.

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“The lady doth protest too much, methinks,” said the Queen Gertrude to Hamlet. Maybe Uros Cufer, Slovenian finance minister, said something similar. He said “We do not have to go to the markets in these overheated times due to Cyprus…We can wait for the markets to calm down, for the investors to feel comfortable about our action and then we will tap the market.” Pressing home his point he also said: “We will need no bail-out this year….I am calm.” And just in case you are still in doubt he also said: “Slovenia cannot be compared to Cyprus. It is certainly not a tax haven… the basic problem of the banks in Slovenia is too much debt in companies and a lack of capital.”

Hamlet had tricked Queen Gertrude. He suspected she and his stepfather had colluded to murder Hamlet’s father. He staged a play to see how she would react to scene in which a woman promises her husband that if he died she would never remarry. Hamlet asked his mother what she thought of the play so far and she replied: “The lady doth protest too much, methinks.” In Elizabethan times the phrase actually meant: “I think the lady is promising too much.”

English lesson over. It matters not. Does Mr Cufer protest or promise too much? It boils down to much the same thing. The markets are fretful; they think Slovenia may be next. Whether next means next to the gallows, to the IMF, or to something else, is not clear.

In one sense though, Slovenia most certainly isn’t Cyprus, or Portugal, Greece, Spain, Italy or even France.

Slovenia’s gross government debt at the end of 2012 was around 52 per cent of GDP. Only three Eurozone countries had less debt. Its unemployment level in February was 9.7 per cent; that is high, but then again it is below the Eurozone average. Slovenia is different in one other way. It is exporting more than it is importing, and is expected to enjoy a current account surplus worth around 3 per cent of GDP this year. Across the euro area, only The Netherlands, Luxembourg and Germany are expected to see a better performance than that.

Slovenia’s problem is that its government debt is rising – the fiscal deficit has been around 5 per cent of GDP every year since 2009, and is forecast to fall only very slowly. Bank liabilities are more than 100 per cent of GDP (much less than Cyprus but still very high) and bank lending to households and business is around 85 per cent of GDP. The country is stuck in recession, and is likely to stay there this year.

Now some might look at those fundamentals and say Slovenia is a bit like the UK, only thanks to its trade surplus in some ways it is better off. It is just that the markets see the UK as a safe haven, and the government can borrow money so cheaply it is a wonder it doesn’t do so more often. In Slovenia bond yields are approaching levels that in the past and in other countries precipitated asking the IMF for help.

The markets are demanding austerity when what Slovenia needs is more demand. And that is why Mr Cufer may indeed be promising and protesting far too much.

©2013 Investment and Business News.

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The evidence is growing.

Take the IMF, for example. According to its latest report on currency reserves, developing countries rid themselves of $45 billion worth of dollars last year. Since Q2 2011 they have sold $90 billion dollars. Over the same period, the developed world has been a net buyer of dollars, and in 2012 was even a net buyer of sterling.

See: Currency Composition of Official Foreign Exchange Reserves (COFER)

Meanwhile, Bloomberg quoted Hans- Guenter Redeker, the head of global currency strategy at Morgan Stanley, who has predicted that within two and half years the euro will be back to parity with the dollar. Capital Economics cited data from the US Commodity Futures Trading Commission which showed that speculative “long futures positions against the euro, sterling and yen combined have topped 200,000 for the first time since last May and are not far off a record high.”

So what’s next? The recent movements in favour of the dollar can’t go on without interruption. Capital Economics predicts some kind of correction in the next few months, but says that looking further ahead to the end of this year and beyond, the dollar is likely to rise further against the euro.

No prizes for guessing why. Following the Cypriot debacle, there is now speculation that Slovenia will be the next Eurozone country to suffer a crisis, and the markets have become scared of the Eurozone. There is a good reason for this. But what about the yen and the good old pound? Central banks in the UK and Japan are expected to hit the QE button hard this year. But so what? Japan’s prime minister and arch dove Shinzo Abe has warned that achieving a 2 per cent inflation target in Japan may not prove possible.

There is an irony here. In the UK, the Bank of England has failed to get inflation even close to target. In Japan, the central bank may fail likewise but in the opposite direction. In Japan, the challenge is getting inflation up. Later this year, rises in commodity prices may lead to a temporary lift in Japanese inflation, but it is far from certain that this will last, and the central bank may yet prove to be impotent.

In the UK we have had £375 billion of QE so far, and while the initial burst may have kicked some life into the economy, subsequent rounds have done very little. The truth is that at a time when banks are being forced to raise capital levels, and the government is afraid to borrow the money, the markets want to lend to it at such cheap rates, QE is about as effective as a leadless pencil. In short, the Bank of England may be impotent too.

For that reason, Capital Economics reckons that while the dollar may well rise against the euro, against the yen and sterling it thinks the rises against the US currency are behind us. Against the euro, of course, it is a different story.

©2013 Investment and Business News.

Investment and Business News is a succinct, sometimes amusing often thought provoking and always informative email newsletter. Our readers say they look forward to receiving it, and so will you. Sign-up here