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Saturday, January 12, 2013

Draghi getting ahead of himself: are we really seeing a “normal situation” in eurozone financial markets?

In his monthly press conference on the 10 January 2013 ECB President Mario Draghi struck a relatively upbeat tone on eurozone, in particular arguing that the eurozone was returning to a “normal situation, from a financial viewpoint”. Don’t get ahead of yourself there, Mario.

True, he also warned against a slowdown in fiscal consolidation and structural reforms due to political complacency, but hinting that we’re now back to a normal finacial market situation seems particularly premature.

Firstly, to state the obvious, the ECB is still massively propping up the financial system in the eurozone. The ECB balance sheet stands at a massive €2.96 trillion up from around €1.5 trillion at the start of 2008. The ECB’s liquidity provision to banks across Europe has slowed in recent months but it remains exorbitantly high, to the point where many banks (particularly in struggling countries) are almost exclusively relying on the ECB for funding. In fact ECB exposure to the PIIGS totalled €1.08 trillion in November 2012. This is by no means normal (or at least shouldn't be).

There is also still significantly limited activity in the interbank lending market, with overnight volumes still near record lows (click graph to enlarge).

Data from the BIS also highlights that longer term bank lending and investment from stronger to weaker states continues to be dramatically below its peak (click to enlarge).

There are many other indicators, such as the limited lending to both businesses and households across the eurozone and the divergence in borrowing costs within different economies (for corporates as well as sovereigns).

Still, the situation in the Eurozone has clearly improved. Some factors, such as the capital outflow from southern to northern countries, have stabilised while others, such as the outflow of deposits from certain banking systems, have shown positive improvement. But we are still miles from being in what many would regard as a “normal situation”.

So when can we expect a “normal situation” to return? Well, with interbank channels having been absent for so long it is hard to expect a rapid turnaround. The ECB is also not expected to exit its massive liquidity provision anytime soon (and even when it does, it will likely be a gradual process), so this will continue to dictate the market. Plenty of other factors (economic growth, unemployment, social stability) also continue to fuel imbalances in the eurozone, so don’t expect cross-border lending or investment in struggling eurozone economies to return to pre-crisis level in the next few months or even years.

This is where the banking union is supposed to come in. However, as we have noted before, the current plans don’t a cross border backstop or a cross border resolution structure for failing banks, for example, so won’t really help in that respect.

Unfortunately, Draghi’s prematurely upbeat comments may have the perverse effect of encouraging the kind of political complacency which he warned about later on in his press conference.


Rik said...

A bit of hogwash from Draghi I am afraid. he let himself been pulled more and more into politics. Probably not the wisest thing to do. Long term bad for his credibility.

Re the economy. Difficult to see where the growth should come from, non of the 3 parties (government, business, consumers) are likely to increase spending. Sooner the other way around.

Banks look to get more and more unhealthy look at intra bank lending goes much faster down than banks' BSs.

Even looking at France. You see mainly investors with a choice going out (at least nett). But yields donot increase. Only explanation is that the arm-twisted/doubling down brigade is stepping in. Same we have seen and see in Spain. Making unhealthy sectors even more unhealthy.

Also the markets simply see it as hogwash (and that could and should have been expected), hard to see why he did it, other than for political reasons.

Problem being that the markets probably see the ECB still as a more credible (fiancially sound) institution than that it really is. While it upholds the whole system at the moment. Basically when the North starts to walk, it is as good for its money as Robert Mugabe and there is a considerable possibility that somewhere on the rescue proces this will happen. He should simply, now that this is not an issue (yet?), not play with his credibility. As the fear of problems is often as bad as the problem itself in the financial amrket.

And as you say as important is the fact that it looks like structural reforms-off time again. Hardly helpful.

Jesper said...

If professional investors will not lend to a bank for a brief period of time then there is a liquidity crisis.

What we're seeing now does look like something we will be seeing for the foreseeable future. So it might credibly be called the new normal.

If the ECB believes this is the new normal, then the ECB believes that the situation is not a liquidity crisis and therefore it must be an insolvency crisis.

This raises the question if the EBA is really needed?
Banks are reluctant to lend to each other and the worst run banks are the most reliant on the ECB for liquidity. If the ECB were to refuse such a bank access to the discount window then that bank would be effectively shut down. In other words, the ECB does have the power to regulate the banks in the periphery.

ECB, centralised organisation with national offices monitoring/regulating banks.
EBA, proposed to be a centralised organisation with national offices monitoring/regulating banks.

I don't see much of a difference, and I doubt that the EBA will be doing much more than employing people at high wages. & some eurocrat will use the EBA as some sort of justification for further funding to the centralised, constantly failing audits, EU administration. Auditors can't produce clean accounts for themselves but we're supposed to believe that they can (and will) audit others correctly?

Rollo said...

are we really seeing a “normal situation” in eurozone financial markets?
Only 'normal' in EU terms, in cloud cuckoo land.

christina speight said...

I've been wondering for some time what hallucigenic substance produces such utterly wonderful visions.

christina speight said...

Draghi has defused the day-to-day crosis but at expense of the 27 mn unemployed wrecked lives in the worsening double-dip recession in the eurozobe. The depression is not quite as severe as in the 1930s which led to Naziism and Fascism but it has lasted longer and is deepening.

It is not just the mediterranean countries either. "Severe material deprivation" has surged in Latvia to 31% and 44% in Bulgaria. There is no hope for these people in their own countries but there's nowhere for them to go. An explosion is inevitable and nobody will then be immune.