Monday, 3 October 2016

European banking crisis

It’s not just Deutsche. European banking is utterly broken

Deutsche Bank
1 October, 2016


A little while back I somewhat unwisely penned a column declaring the financial crisis essentially over. All I meant by this was that with the return of full employment and rising living standards, most of the economic wounds of the crisis had healed, at least in the US and the UK.

Yet as is evident from the events of the last week, the banking crisis itself is far from over. Nine years after the initial eruption, it still rumbles on, with the epicentre now moved from the US to Europe. Only it’s not the same crisis; in large measure, it is completely different.

Today’s mayhem is not so much the result of reckless bankers and asleep at the wheel regulators, but rather of the public policy response to the last crisis itself – that is to say, regulatory over-reach and central bank money printing.

Much the same disease as afflicts Continental banks also applies to British counterparts, including Royal Bank of Scotland, Barclays and even Lloyds.
All eyes are naturally focused on the specific problems of Deutsche Bank, but Deutsche is in truth no more than the canary in the coal mine. As Tidjane Thiam, chief executive of Credit Suisse, observed last week, as an entire sector, European banks are still “not really investable”. Much the same disease as afflicts Continental banks also applies to British counterparts, including Royal Bank of Scotland, Barclays and even Lloyds.

All are fast being enveloped by a perfect storm of negatives, and this time around, it is substantially the policymakers and law enforcers who are to blame.

There are essentially four factors at work here. First, it’s virtually impossible to make money out of banking in a zero interest rate environment, frustrating attempts to rebuild capital buffers after the bad debt write-downs of recent years. In circumstances where central banks have bought right along the yield curve, flattening it down to virtually nothing, the margin from maturity transformation all but disappears.

Much the same thing has happened to the once lucrative returns of investment banking. Even Goldman Sachs has been forced to admit that it is struggling to cover its cost of capital.

Second is ever tougher international capital requirements, the latest instalment of which is dubbed Basel IV. The renewed crackdown is understandable, given what occurred nine years ago, but also ill-conceived and discriminatory, unfairly penalising European banks against their American counterparts.

The technical details need not concern us too much here, suffice it to say that in order to stop banks gaming the system, regulators are attempting to impose a so-called “output floor”, tightly limiting the scope for easier capital requirements on risk weighted assets.

US banks won’t be nearly as badly hit by the measure as their European counterparts, which is no doubt why their regulators are gunning so hard for it.

Third comes the apparently never ending misery of misconduct fines, which for the US seem to have become just another way of further taxing the banks, particularly the European ones, routinely threatened as they are with removal of their dollar clearing licences should they try to resist. Nine years after the event, there is still no let up. It’s a classic case of justice delayed being justice denied.

Typically, banks to settle for around half the amount initially demanded, as now seems likely with Deutsche Bank, but even so, the fines seem to be assessed almost wholly on ability to pay rather than the extent of the misconduct itself. This renders raising more capital from investors a non starter. Why put up extra capital when you know it will just get snaffled by the US Department of Justice?

The political posturing involved is quite breathtaking. The Department of Justice is hoping to secure a giant omnibus settlement involving Deutsche, Credit Suisse and Barclays all rolled into one, timed for announcement just ahead of the presidential election. It’s Royal Bank of Scotland’s turn next – not good given that its exposure to the sub-prime debacle was even larger than Deutsche Bank’s.

On top of all this comes the challenge of fintech, which is threatening to eat the incumbents’ lunch.

Despite the parallels, Deutsche is not Lehman’s in redux. If necessary, Angela Merkel will bail the bank out, politically embarrassing though it will be for her. Whatever the cost, Germany is more than solvent enough to take the hit. Unlike previous legs in Europe’s interminable banking crisis, there is no risk of fiscal contagion.

What all this will do, however, is cause banks further to contract their balance sheets, perpetuating the wider economic impact of the crisis. It all goes to show that there is no mess quite so bad that government intervention to correct it won’t make even worse.

And there I was thinking that part of the purpose of Brexit was a bonfire of supposedly crippling European business regulation, including onerous labour market restrictions. Not at all. If anything, the new Government seems intent on beefing up the protections even further with its own home grown variety.

Theresa May plans to make “improving the security and rights of ordinary working people” a key part of her message to the Conservative Party conference this week. "Responsible capitalism" is the name of the game.

This is a noble aim, as well as astute politics. In Sports Direct, we’ve seen a particularly egregious example of the creeping return of Victorian working practices. It's been obvious for a long time that policy needs to respond to the digital age, as well as the ravages of globalisation.

I’m sure the new Government will be measured in its approach. But however well intentioned, most labour market protections end up simply depriving someone else of a job. And when it comes to worker directors, and curbs on executive pay, which is another part of the Government’s agenda in this area, it turns into mere, but potentially quite damaging, political posturing and point scoring. Britain will need all the inward investment it can get post Brexit.

This scarcely looks a good way of going about it. An “up the workers” agenda can quite quickly turn into an anti-business one.

I do hope Tony Hayward enjoys Deepwater Horizon, the action packed movie based on the Gulf of Mexico oil spill he presided over as chief executive of BP. Since then, Mr Hayward has indeed managed to get his life back, his professed wish when attempting to manage the crisis. But perhaps not as much as he would have liked.

Even a few years back when the oil price was still riding high, investing in war torn Iraqi Kurdistan seemed a mad idea and so it has proved. Since their over-hyped peak two years ago, shares in his Genel Energy have lost 90pc of their value. He’s already bowed out as chief executive, and now he’s quitting as chairman. Plenty of time for going to the movies, then.

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