The Euro Crisis through the Lens of Capital Flow Reversals

Transcription

1 The Euro Crisis through the Lens of Capital Flow Reversals Hyun Song Shin Boston College 4 December 2012

2 The Euro Crisis through the Lens of Capital Flow Reversals 1 Three (Interlocking) Features of the Euro Crisis Sovereign debt crisis Banking crisis Balance of payments crisis Cross-border capital flow reversal SuddenStop Common thread is the bank leveraging/deleveraging cycle

3 The Euro Crisis through the Lens of Capital Flow Reversals 2 Corporate Finance of Banking A L Equity Assets Debt

4 The Euro Crisis through the Lens of Capital Flow Reversals 3 A L A L Assets Equity Debt Assets Equity Debt

5 The Euro Crisis through the Lens of Capital Flow Reversals 4 A L A L Assets Equity Debt Assets Equity Debt

6 The Euro Crisis through the Lens of Capital Flow Reversals 5 1,000 Barclays: 2 year change in assets, equity, debt and risk-weighted assets ( ) 2 year change in equity, debt and risk-weighted assets (billion pounds) y = x R 2 = yr RWA Change 2yr Equity Change 2yr Debt Change -1,000-1, ,000 2 year asset change (billion pounds) Figure 1. Barclays: 2 year change in assets, equity and debt( )(source: Bankscope)

7 The Euro Crisis through the Lens of Capital Flow Reversals 6 Societe Generale: 2 year changes in assets, risk-weighted assets, equity and debt ( ) year change in risk-weighted assets, equity and debt (billion euros) y = x R 2 = y = x yr debt change 2yr equity change 2yr RWA change year asset change (billion euros) Figure 2. Société Générale: 2 year change in assets, equity and debt( )(source: Bankscope)

8 The Euro Crisis through the Lens of Capital Flow Reversals 7 Core and Non-Core Bank Liabilities Core: Liabilities to domestic household and non-financial claim holders Non-Core: Liabilities to financial intermediaries and foreign creditors Ratio of non-core to core liabilities is: Procyclical Mirrors lowering of credit standards

9 The Euro Crisis through the Lens of Capital Flow Reversals 8 Borrowers Banking Sector Domestic Depositors

10 The Euro Crisis through the Lens of Capital Flow Reversals 9 New Borrowers Borrowers Banking Sector Foreign Creditors Domestic Depositors

11 The Euro Crisis through the Lens of Capital Flow Reversals 10 Composition of Northern Rock's Liabilities (June June 2007) Equity Billion pounds Other Liabilities Securitized notes 60 Retail Deposits Jun-07 Dec-06 Jun-06 Dec-05 Jun-05 Dec-04 Jun-04 Dec-03 Jun-03 Dec-02 Jun-02 Dec-01 Jun-01 Dec-00 Jun-00 Dec-99 Jun-99 Dec-98 Jun-98 Figure 3. Liabilities of Northern Rock( )(Source: Shin(2009))

12 The Euro Crisis through the Lens of Capital Flow Reversals 11 Credit Quality and Non-Core Bank Liabilities Non-core liabilities reflect expansion in lending beyond normal levels Loans financed by non-core liabilities are of lower credit quality Even if liquidity support is forthcoming, loans made with lower credit standards go bad eventually Prolonged economic slumps exacerbate bad loans, without or without liquidity support(e.g. Japan) Short-term non-core is vulnerable to reversal

13 The Euro Crisis through the Lens of Capital Flow Reversals 12 Trillion Won [Other] FX borrowing [Lf] Debt Securities [Lf] Repos [M2] Promissory Note 2 [M2] Promissory Note 1 [M2] Certificate of Deposit Jan-09 Jan-07 Jan-05 Jan-03 Jan-01 Jan-99 Jan-97 Jan-95 Jan-93 Jan-91 Figure 4. Non-core liabilities of Korean banks(source: Shin and Shin(2010), data from Bank of Korea)

14 The Euro Crisis through the Lens of Capital Flow Reversals Non-Core Liabilities as Fraction of M Jan Jan Jan-10 Jan-09 Jan-08 Jan-07 Jan-06 Jan-05 Jan-04 Jan-03 Jan-02 Jan-01 Jan-00 Jan-99 Jan-98 Jan-97 Jan-96 Jan-95 Jan-94 Jan-93 Jan-92 Jan-91 Figure 5. Non-core liabilities of Korean banks as proportion of M2(Source: Shin and Shin(2010), data from Bank of Korea)

15 The Euro Crisis through the Lens of Capital Flow Reversals 14 Trillion Euros Crossborder claims in domestic currency of eurozone banks Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q1 Crossborder liabilities in domestic currency of eurozone banks Figure 6. Cross-border euro-denominated claims and liabilities of eurozone banks (Source: BIS Locational Statistics, Table 5A)

16 The Euro Crisis through the Lens of Capital Flow Reversals 15 30% 25% 20% 15% 10% 5% 2011-Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q1 0% -5% -10% -15% -20% Figure 7. Four quarter growth rate of cross-border euro-denominated liabilities of eurozone banks (Source: BIS Locational Banking Statistics Table 5A)

17 The Euro Crisis through the Lens of Capital Flow Reversals 16 Claims of European Banks on Counterparties in Spain Trillion Dollars Other European BIS reporting countries Switzerland United Kingdom France Q Q Q Q Q Q Q Q Q Q Q Q4 Germany Figure 8. Foreign claims of European BIS-reporting banks on counterparties in Spain (Source: BIS consolidated banking statistics, Table 9D)

18 The Euro Crisis through the Lens of Capital Flow Reversals 17 Claims of European banks on Counterparties in Ireland Trillion Dollars Other European BIS reporting countries Switzerland United Kingdom France Q Q Q Q Q Q Q Q Q Q Q Q4 Germany Figure 9. Foreign claims of European BIS-reporting banks on counterparties in Ireland (Source: BIS consolidated banking statistics, Table 9D)

19 The Euro Crisis through the Lens of Capital Flow Reversals 18 Current Account Balance as % of GDP Ireland Spain Current Account Balance as % of GDP -10% Figure 10. Current account of Ireland and Spain(Source: IMF International Financial Statistics)

20 The Euro Crisis through the Lens of Capital Flow Reversals 19 Trillion Euros Dec trillion IE_8.9.12,13,14 Other loans to households and nonprofits IE_8_9.11 Credit for purchase of consumer durables IE_8_9.10 Credit for homeownership billion Dec _9.9-9_9.10 Home improvement credit IE_8_9.7 Loans for real estate financing IE_8_9.5 Credit for construction funding 8_9.6-8_9.7 Credit financing services (non real estate) IE_8_9.4 Credit financing industry (excluding construction) IE_8_9.3 Credit for financing agriculture, hunting, forestry and fishing Figure 11. Spain: banking sector total domestic credit(source: Bank of Spain)

21 The Euro Crisis through the Lens of Capital Flow Reversals 20 Trillion Euros Dec 1998 IE_8_2.5 Other bank liabilities (deposits > 3m, securities and repos) held by households, nonfinancial corporations and non-profits billion IE_8_2.1 Cash and deposits (<3m) held by households, nonfinancial firms and non-profits Dec-11 Dec-10 Dec-09 Dec-08 Dec-07 Dec-06 Dec-05 Dec-04 Dec-03 Dec-02 Dec-01 Dec-00 Dec-99 Dec-98 Dec-97 Dec-96 Dec-95 Figure 12. Spain: Core liabilities of banking sector(source: Bank of Spain)

22 The Euro Crisis through the Lens of Capital Flow Reversals 21 Trillion Euros Private crossborder liabilities (total credit - core liabilties - Eurosystem LTRO Eurosystem Long term refinancing operations Core Liabilities to residents Dec-11 Dec-10 Dec-09 Dec-08 Dec-07 Dec-06 Dec-05 Dec-04 Dec-03 Dec-02 Dec-01 Dec-00 Dec-99 Figure 13. Spain: funding gap of Spanish banks(source: Bank of Spain)

23 The Euro Crisis through the Lens of Capital Flow Reversals 22

24 The Euro Crisis through the Lens of Capital Flow Reversals 23 ECB

25 The Euro Crisis through the Lens of Capital Flow Reversals 24 ECB

26 The Euro Crisis through the Lens of Capital Flow Reversals 25 Billion Euros Private crossborder liabilities (total credit - core liabilties - Eurosystem LTRO Eurosystem Long term refinancing operations 0 Mar-12 Mar-11 Mar-10 Mar-09 Mar-08 Mar-07 Mar-06 Mar-05 Mar-04 Mar-03 Mar-02 Mar-01 Mar-00 Mar-99 Figure 14. Spain: funding gap of Spanish banks(source: Bank of Spain)

27 The Euro Crisis through the Lens of Capital Flow Reversals Non-core to core liabilities ratio Mar-12 Sep-11 Mar-11 Sep-10 Mar-10 Sep-09 Mar-09 Sep-08 Mar-08 Sep-07 Mar-07 Sep-06 Mar-06 Sep-05 Mar-05 Sep-04 Mar-04 Sep-03 Mar-03 Sep-02 Mar-02 Sep-01 Mar-01 Sep-00 Mar-00 Sep-99 Mar-99 Figure 15. Spain: Ratio of non-core liabilities to core liabilities of Spanish banks(source: Bank of Spain)

28 The Euro Crisis through the Lens of Capital Flow Reversals 27 Billion Euros Loans and advances to Spanish government Spanish government securities Securities issued by Spanish enterprises and households 150 Loans and advances to Spanish enterprises and households 100 Spanish money market paper, bonds and notes 50 Securities issued by Spanish banks 0 Loans and advances to Spanish banks Figure 16. Claims of German banks on Spanish counterparties(source: Bundesbank)

29 The Euro Crisis through the Lens of Capital Flow Reversals 28 Billion Euros 2,000 1,800 1,600 1,400 1,200 1, Other USA Austria Finland Greece Ireland Portugal Canada Italy Netherlands Switzerland Norway UK France Sweden Germany Denmark Spain Figure 17. Mortgage covered bonds outstanding by country and by year (Source: European Covered Bond Council Factbook 2012)

30 The Euro Crisis through the Lens of Capital Flow Reversals Billion Euros Other USA Austria Finland Greece Ireland Portugal Canada Italy Netherlands Switzerland Norway UK France Sweden Germany Denmark Spain Figure 18. Mortgage covered bonds outstanding by country and by year (Source: European Covered Bond Council Factbook 2012)

31 The Euro Crisis through the Lens of Capital Flow Reversals 30 Billion Euros Spain: stock of mortgage covered bonds (end year) Spain: new issuance of mortgage covered bonds Figure 19. Spain: stock and new issuance of mortgage covered bonds (Source: European Coveren Bond Council)

32 The Euro Crisis through the Lens of Capital Flow Reversals % 90% 80% Other Iberia 70% 60% 50% Benelux UK & IRL 40% 30% 20% Nordics France 10% 0% Germany Figure 20. Covered bond investors by residence(source: European Covered Bond Council 2012)

33 The Euro Crisis through the Lens of Capital Flow Reversals % 90% 80% 70% 60% 50% 40% 30% 20% 10% Other Central banks Insurance & pension funds Asset managers Banks 0% Figure 21. Covered bond investors by type of institution(source: European Covered Bond Council 2012)

34 The Euro Crisis through the Lens of Capital Flow Reversals 33 Comparing Spain and Korea Both Korea and Spain highlight role of non-core liabilities Korea s non-core is Shortmaturity Denominated in foreign currency Spain s non-core is Medium to long maturity Denominated in domestic currency Euro crisis is a tale of cross-border banking flows in domestic currency

35 The Euro Crisis through the Lens of Capital Flow Reversals 34 Some Historical Parallels for Spain USmortgagecrisis2007 Japan s bursting bubble Slow deleveraging eventually results in bad assets and public recapitalization of banks How much? How soon? How? Some lessons from Japan

36 The Euro Crisis through the Lens of Capital Flow Reversals 35 M2 Loans and Discounts Trillion Yen / / / / / / / / / / / / / / / / / / / / / / / / /01 Figure22. Japan: Loansanddiscountsofmajorandregionalbanks(inred)andM2moneystock(inblue) (Source: Flow of Funds, Bank of Japan)

37 The Euro Crisis through the Lens of Capital Flow Reversals 36 Trillion Euros Sept 2012 Loans to nongovernment borrowers Deposits due to non-banks 3.0 Jul-12 May-11 Mar-10 Jan-09 Nov-07 Sep-06 Jul-05 May-04 Mar-03 Jan-02 Nov-00 Sep-99 Jul-98 May-97 Mar-96 Jan-95 Figure 23. Numerator is loans to non-mfis (monetary and financial institutions), excluding general government. Denominator is deposit liabilities to non-mfis excluding central government(source: European Central Bank)

38 The Euro Crisis through the Lens of Capital Flow Reversals Sept Sep-12 Jun-11 Mar-10 Dec-08 Sep-07 Jun-06 Mar-05 Dec-03 Sep-02 Jun-01 Mar-00 Dec-98 Sep-97 Figure 24. Eurozone: Loan to deposit ratio. Numerator is loans to non-mfis (monetary and financial institutions), excluding general government. Denominator is deposit liabilities to non-mfis excluding central government(source: European Central Bank)

39 The Euro Crisis through the Lens of Capital Flow Reversals 38 Normalized loans (Japan) Normalized Loans (Euro area) Normalized loans Sept Crisis date Japan (Jan 1991) Eurozone (Sept 2008) Months from crisis date Figure 25. Eurozone and Japan: Loans ineuro area (inred) and in Japan(in blue) normalizedto1.0at crisis date, and measured in months from the crisis date. Eurozone crisis date is September Crisis date for Japan is January 1991(between stock market peak and real estate peak)

40 The Euro Crisis through the Lens of Capital Flow Reversals Fiscal Cost (% of GDP) Sweden Norway Finland Malaysia Mexico Japan South Korea Uruguay Thailand Chile Indonesia Argentina Figure 26. Fiscal costs of banking crises(source: Patrick Honohan and Daniela Klingebiel(2000) Controlling Fiscal Costs of Banking Crises, World Bank)

41 The Euro Crisis through the Lens of Capital Flow Reversals 40 Credit to GDP ratio (%) Japan JPN 140 Spain ESP Figure 27. Ratio of domestic private credit to GDP(Source: World Bank)

42 The Euro Crisis through the Lens of Capital Flow Reversals 41 Lessons for Eurozone from Japan Liquidity versus solvency Comparing Eurozone LTRO with BOJ s monetary policy in 90s Loans granted during the bubble phase almost always go bad, and must be written off eventually... Pre-condition for restructuring is political will, which needs shared diagnosis of crisis Japan s deleveraging started 7 years after crisis date(see figue) Restructuring entails fiscal costs, which is an added complication in Eurozone Question: How well can the institutions and governance structure of the Eurozone cope with strains of the restructuring process?