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Deutsche Bank Research On European Bank Recapitalization, Lending & China

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Recapitalising European banks: No drama please, we are Europeans

On Columbus Day, Oct 13, 2008, Henry Paulson famously locked up nine CEOs in his conference room, cajoling them to sign up, on the dotted line, for a forced recapitalisation by the state. Many market participants expect no less to happen in Europe these days.

They will be disappointed. Under existing law, authorities could only force higher capital levels onto banks by means of Pillar 2 surcharges. However, this would have to be justified in each individual case (a lengthy process) and is a largely untested road. Alternatively, EU lawmakers could amend the CRD, stipulating higher capital levels for all European banks – again, however, a lengthy process and not one that could easily be targeted to specific (i.e. systemically relevant) banks. Smaller banks would object strongly. Even if banks were to accept state capital injections “voluntarily”, they could only do that if sufficient authorised capital were available or if a general meeting of shareholders had approved. Thus, to quickly (and forcefully) raise capital levels, authorities would have to pass emergency legislation (similar to the autumn of 2008) that would override existing laws and the rights of existing shareholders. For this, however, governments would have to prove that a major disaster was imminent and that less intrusive means, e.g. action by banks themselves, were not available. The latter could, for instance, be the case if governments claimed that capital levels of, say, 12% CT1 were necessary to restore confidence – i.e. levels that banks realistically could never attain quickly in private markets. However, setting such a hurdle would obviously make recapitalisation very costly for governments (or quickly deplete the EFSF). All in all then, it is likely that (i) banks will be given the chance and several months to raise capital in the markets first; and (ii) national governments will, if necessary, provide funds to close any gaps and EFSF funds will only be made available to those banking systems where the sovereign is no longer in a position to do so. Hence, no Columbus Day-like drama for Europe.

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Euro area bank lending: Only muted reactions to the crisis, so far

Predictably, banks in the euro area tightened their lending standards in Q3 2011 and more expect to tighten further in Q4, according to the latest ECB Bank Lending Survey. The net percentage of banks reporting a tightening of standards to non-financial corporations went up to 16% (Q2: 2%; Q4e: 22%). For mortgage lending (18%; Q2: 9%), no deterioration is expected for Q4 (Q4e: 11%).

As was to be expected, concerns over funding have replaced the economic outlook as the main driver for lending standards. Given the extent of funding disruptions, the tightening of lending standards is actually surprisingly restrained. More surprising and worrying is the steep fall in loan demand (corporates Q3: -8%; Q2: 4%; Q4e: -19% and mortgages Q3: -24%; Q2: -3%; Q4e: -22%), suggesting that corporates and households are again putting off investment decisions. Incidentally, loan demand in Germany is holding up much better – actually, it is still reported to be expanding.

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China: Bracing for tough times

Central Huijin, China’s sovereign wealth fund subsidiary and shareholder in China’s big-four state-owned banks, purchased shares of those banks in the Shanghai-A market, triggering an immediate, if short-lived, sharp rebound in their value. China appears to be preparing for growing difficulties in the global economy. Central Huijin’s purchase is not a capital injection exercise as it was a purchase of existing shares in the secondary market. It’s also not the first time that it has made such a move. Huijin purchased shares of these banks, shortly after Lehman’s collapse in September 2008, to stem selling pressure. Back then, the move provided temporary relief but bank share prices fell again afterwards. It was only after the government’s stimulus package was announced that bank shares rebounded more sustainably. This time around there is no guarantee that another stimulus package will follow, but the purchase seems to signal Beijing’s increasing concerns on the global outlook (and perhaps also about emerging domestic banking sector risks) and their willingness to use financial resources preemptively.

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Copyright © 2011 • Deutsche Bank AG, DB Research

Deutsche Bank Research is responsible for macroeconomic analysis within Deutsche Bank Group and acts as consultant for the bank, its clients and stakeholders. We analyse relevant trends for the bank in financial markets, the economy and society and highlight risks and opportunities. DB Research delivers high-quality, independent analysis and actively promotes public debate on economic, fiscal, labour market and social policy issues.

Published by kind permission of Thomas Mayer.

 

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