European financial markets and policy trends

Transcription

1 Financial Markets Panel 11th Meeting Reference Materials European financial markets and policy trends 6 July 21 Tetsuya Inoue Chief Researcher, Center for Financial Market Research Nomura Research Institute

2 1. European financial markets and policy trends Assessment of key markets based on talks with market participants Market Assessment Issues 1. Money Market indicators have settled down somewhat Occasional situations in which short-term funds have been aggressively bid However, ECB continues to serve as market maker of last resort 2. Government debt While risks of Greek government debt have increased, Spanish government debt auctions have generally gone smoothly Many are not happy with ECB purchases of government debt In leading economies, stagnant growth and dis-inflation have contributed to stable long-term bond yields 3. Credit European banks are becoming increasingly selective about who they lend to -Focus for now is on the Spanish financial system Funding situation at banks in problem countries and banks with substantial exposure to the same -Including impact of earnings announcements and release of stress test results Uncertainty surrounding Greek economic programs Concerns about resurgence of problems in eastern Europe Impact of fund inflows to Germany and Switzerland Measures to stabilize Spanish financial system Longer-term funding risk -Both roll-over of bonds issued in response to crisis and equity financing to boost capital bases 4. Foreign Exchange Downward pressure on euro has eased somewhat, partly due to USD weakness Upward pressure on Swiss franc is expected to persist Future economic trends in problem countries and effectiveness of EU response Conduct of monetary policy by ECB and SNB Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 1

3 1. European financial markets and policy trends Source:Thomson Reuters Economic performance of central and southern Europe Real GDP Growth(%) 2-2 EU Germ any France -4-6 G reece Italy Irelan d Portugal Spain -8 24Q1 25Q3 27Q1 28Q3-1 21Q1 24Q1 25Q3 27Q1 28Q3-1 21Q EU G erm any France CPI Inflation(%) G reece Irelan d -1-1 Italy Portugal -2-2 Spain -3 Jan-3 A pr-4 Jul-5 Oct-6 Jan-8 A pr-9 Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. -3 J a n - 3 A p r-4 J u l- 5 O ct- 6 Ja n -8 A p r- 9 2

4 1-1. European financial markets and ECB response Money market Source:ECB, Thomson Reuters Policy rate and money market rate (EONIA) % 5 EONIA(standard deviation <25 business days>).5 P o licy R a te EONIA Aug-8 Nov-8 Feb-9 May-9 Sep-9 Dec-9 Mar-1 Jun-1 Aug-8 Nov-8 Feb-9 M ay-9 Sep-9 Dec-9 Mar-1 Jun EUR GBP 1.75 EUR GBP CHF Libor-OIS spread (Left:1M, Right:3M) CHF.5 percent point Jan-8 M ay-8 Sep-8 Jan-9 M ay-9 Sep-9 Jan-1 M ay-1 Jan-8 May-8 Sep-8 Jan-9 May-9 Sep-9 Jan-1 May-1 Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 3

5 1-1. European financial markets and ECB response Source:BIS Bank loans to southern European countries (BIS Consolidated Banking Statistics: Dec 29) $ bn Europe Other Spain Belgium France Germany Italy Netherland Switzerland UK US Japan Developed Europe 1, ,267 2, ,76 1, Greece Portugal Ireland Spain Italy 1, Loans to Greece Loans to Portugal 3.2% 36.3% France 17.9% France Germany Netherland Germany Netherland 47.4% UK Other 7.1% UK Other 18.9% 5.6% 2.7% Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved % 5.6%

6 1-1. European financial markets and ECB response $ bn Europe Other Austria Belgium France Germany Italy Netherlands Switzerland Source:BIS Bank loans to eastern European countries (BIS Consolidated Banking Statistics: Dec 29) UK US Japan Developing Europe 1, Czech Hungary Latvia 3 3 Poland Romania Loans to Czech Loans to Hungary 32.8% 33.4% Austria France Germany Italy 25.4% 26.3% 7.9% Austria France Germany Italy 8.% 6.8% 19.1% Other 17.8% 22.7% Other Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 5

7 1-1. European financial markets and ECB response Bank loans to specific areas and economies Source:BOE Domestic Loans by European banks to specific areas (BOE Financial Stability Report<June, 21>) Cross-border Estimated position of foreign exchange by major European banks (BOE Financial Stability Report<June, 21>) CEE: Czech, Estonia, Hungary, Latvia, Lithuania, Poland CIS:Kazakhstan, Russia, Ukraine Balkans: Bulgaria, Croatia, Serbia, Romania Credit to non-banks are assumed to be long-term, and those to banks to be short-term Borrowings from non-banks are assumed to be long-term at the minimum, and those to be short-term at the maximum Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 6

8 1-1. European financial markets and ECB response The ECB s two structural problems Issue Details Relationship with monetary policy 1. Prevent financial stress from expanding Crisis measures had to be bolstered as the financial stress grows -The European Commission responded to the situation in problem countries, but markets are worried about the lack of progress on financial institutions holding bonds issued by the governments in these countries Most important task is supporting the funding needs of banks holding bonds issued by problem countries -Key issue for the ECB is managing operations and eligible collateral -Policy authorities are equipped with innovative options that were already utilized in previous years; which is a positive Management of government debt purchases involves a variety of problems -Many objections from the region; concerns remain about how to respond if problems worsen -This could become an important issue with the potential to affect the review of European financial supervision 2. Achieve right mix of policy with fiscal consolidation Something is needed to offset the fiscal drag resulting from fiscal consolidation -Fiscal austerity measures are likely to be implemented in key economies as well as in problem countries This problem is shared by the US and Japan -In Europe, of course, measures have been implemented in the midst of a financial crisis Measuring cost of prolonged low interest rates due to extended fiscal tightening -Little risk of asset price inflation for now? Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 7

9 1-1. European financial markets and ECB response Crisis measures by the ECB Measures Supplementary measures Source:ECB Supplementary Longer-Term Refinancing Operation <SLTRO> Security Markets Program Full allotment (at the policy rate) for 3-month terms Full allotment (at the average of minimal successful rates of MRO) for 6-month terms Purchase public and private debt in EMU -for the purpose of improvement of market liquidity and of security of monetary policy transmission -sterilizing the funds with market operations Maintenance of Greek government bonds as eligible collateral (April, 21) -Special treatment after its downgrades Revival of USD-fund operation (May, 21) -with terms of 7 days and 84 days (Reference) Crisis measures since 27 Duration Allotment Others Main Refinancing Operation<MRO> Supplementary Longer- Term Refinancing Operation<SLTRO> One-Year Long-Term Refinancing Operation <One-year LRO> Occasional extension to 2 weeks in stressful periods (such as over semiannual terms) Introduced as operations with 3-month terms (August, 27) Operations with 6-month terms are added (March, 28) Introduced as operations with 1 yearterms (June, 29) Full allotment (at the policy rate) in auctions since October, 28 Full allotment (at the policy rate) in auctions since November, 21 Full allotment Introduction of foreign currency operations (December, 27) -USD and CHF -with terms 7-days, 28-days and 84-days Expansion the set of eligible collateral (Octver, 28) -bonds in USD, GBP and JPY -bank CD (with restrictions) -lowest rating lowered to BBB- (with the exception of ABS) Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 8

10 1-1. European financial markets and ECB response LTROs (since December, 29) LTRO (with terms shorter than 3-month) LTRO(with terms longer than 6-months) Source:ECB Execution Duration Amount(mn EUR) Successful Bidders Execution Duration Amount (mn EUR) Successful Bidders 29/12/ /12/ /1/ /12/ /2/ /12/ /3/ /4/ /4/ /5/ /5/ <Reference> USD operation 21/6/ /12/ LTRO (with terms 3-months) 29/12/ /12/ /12/ /1/ /1/ /2/ /1/ /4/ /1/ /4/ /1/ /5/ /5/ /7/ /5/2 7 <Reference> Remaining LTROs with 1-year terms 21/5/ /1/ /5/ /12/ /6/3 7 * All the USD operations since 3 June do not have any subscriptions. Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 9

11 1-1. European financial markets and ECB response Source:ECB Scale of operation 1,4, 1,2, 1,, 8, Outstanding amount of respective operations (mn EUR) 5, 4, 3, Outstanding amount of current account (mn EUR) Deposit Facility Reserve Balance Required Reserves Excess Reserves Excess Reserves plus Deposit Facility 6, 2, 4, 2, 1, Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Marginal Lending Facility Long-Term Refinancing Operations Foreign Exchange Fine-Tuning Operations Main Refinancing Operations Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 1

12 1-1. European financial markets and ECB response Source:ECB ECB s balance sheet 2,5, mil EUR 2,, Foreign Exchange 1,5, 1,, Main Refinancing Operations Long-Term Refinancing Operations Fine-Tuning Operations Marginal Lending Facility Other Credits Government Securities Other Securities Gold Other Assets 5, Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 11

13 1-1. European financial markets and ECB response Balance sheet of European banks 35 Source:ECB 3 Left:Total EMU economies Lower left:germany Lower right:france (bn EUR) Stock Other Bonds Government Bonds MFI Bonds Other Loan Loan to Household Loan to Non-Financial Loan to MFI External Asset Other Asset 1 Jan-4 Oct-4 Jul-5 Apr-6 Jan-7 Oct-7 Jul-8 Apr-9 Jan Jan-4 O ct-4 Jul-5 A pr-6 Jan-7 O ct-7 Jul-8 A pr-9 Jan-1 Jan-4 Oct-4 Jul-5 Apr-6 Jan-7 Oct-7 Jul-8 Apr-9 Jan-1 Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 12

14 1-1. European financial markets and ECB response Balance sheet of European banks 1 Source:ECB Left:Greece Lower left:spain Lower right:italy (bn EUR) Stock Other Bonds Government Bonds MFI Bonds Other Loan Loan to Household Loan to Non-Financial Loan to MFI External Asset Other Asset Jan-4 O ct-4 Jul-5 A pr-6 Jan-7 O ct-7 Jul-8 A pr-9 Jan Jan-4 O ct-4 Jul-5 Apr-6 Jan-7 Oct-7 Jul-8 Apr-9 Jan-1 Jan-4 Oct-4 Jul-5 Apr-6 Jan-7 Oct-7 Jul-8 Apr-9 Jan-1 Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 13

15 1-1. European financial markets and ECB response Balance sheet of European banks Upper:Switzerland (bn CHF) Lower:UK (bn GBP) Source:SNB, BOE, ECB Reductions in assets by major banks Switzerland UK Total assets of two major banks: 2.34 trn CHF (Dec. 27) 1.5 trn CHF (Mar. 21) <reduction by approx. 36%> Total assets of major banks*: 9.28 trn GBP (Dec. 28) 7.4 trn GBP (Dec. 29) <reduction by approx. 2%> * Aggregate domestic assets held by Santander, Bank of Ireland, Barclays, CSFB, HSBC, Lloyds, NAB, Nationwide, Northern Rock and RBS. Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 14

16 Source:Thomson Reuters 1-2. European government bond markets and policy response Government bond markets in southern and eastern European countries bp 9 Government bond in southern European countries bp 4 1 bp Government bond in eastern European countries 8 7 Portugal Ireland Italy Greece Spain Portugal Ireland Italy Greece Spain 2 Aug-8 Dec-8 Apr-9 Aug-9 Dec-9 Apr-1-2 Aug-8 Dec-8 Apr-9 Aug-9 Dec-9 Apr-1 Left: Yield spreads against Bunds (1-year) Right: Yield spreads between 2Y notes and 1Y Bonds Aug-8 Dec-8 Apr-9 Aug-9 Dec-9 Apr-1 Poland Hungary Czech Slovakia Bulgaria (Yield spreads against Bunds <1-year>) Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 15

17 6 Government bonds in central European countries Source:Thomson Reuters 1-2. European government bond markets and policy response DE2Y GB2Y CH2Y Bond yield(%) (Left:2-year ) (Right:1-year) DE1Y GB1Y CH1Y Jan-8 Apr-8 Aug-8 Nov-8 Mar-9 Jun-9 Sep-9 Jan-1 Apr-1 Jan-8 Apr-8 Aug-8 Nov-8 M ar-9 Jun-9 Sep-9 Jan-1 Apr DE5Y-2Y GB5Y-2Y CH5Y-2Y Yield spreads <percent point> (Left:5Y-2Y) (Right:1Y-2Y) DE1Y-2Y GB1Y-2Y CH1Y-2Y Jan-8 Apr-8 Aug-8 Nov-8 Mar-9 Jun-9 Sep-9 Jan-1 Apr-1 Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. -.5 Jan-8 Apr-8 A ug-8 N ov-8 M ar-9 Jun-9 Sep-9 Jan-1 A pr-1 16

18 Foreign exchange markets in Europe Source:Thomson Reuters, BOE 1-2. European government bond markets and policy response EURUSD GBPUSD USDCHF EURGBP EURCHF Jan-8 M ay-8 Sep-8 Jan-9 M ay-9 Sep-9 Jan-1 M ay Mar-8 Jul-8 D ec-8 May-9 Sep-9 Feb-1 Jun EUR GBP CHF Nominal effective rates 25 EURUSD GBPUSD USDCHF Jan-8 Apr-8 Aug-8 Dec-8 M ar-9 Jul-9 Nov-9 Feb-1 Jun-1 Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 1 5 Implied volatility (against USD:1M) Jan -8 M ay - 8 S ep -8 Jan -9 M ay-9 S ep -9 Jan -1 M ay-1 17

19 1-2. European government bond markets and policy response Economic performance of central and southern European countries 5 5 Source:Thomson Reuters EU -2 Germany -3 France -4-5 Jan-3 A pr-4 Jul-5 O ct-6 Jan-8 A pr-9 8 Real policy rate deflated by CPI (%) G reece -2 Ireland -3 Italy Portugal -4 Spain -5 Jan-3 A pr-4 Jul-5 Oct-6 Jan-8 A pr Germany -2 France -4-6 Jan-3 A pr-4 Jul-5 Oct-6 Jan-8 A pr-9 Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. Real government bond rate deflated by CPI (%) G reece Irelan d Italy Portugal Spain -6 Jan-3 A pr-4 Jul-5 Oct-6 Jan-8 A pr-9 18

20 Policy rates Source:ECB, BOE, SNB, Thomson Reuters 1-2. European government bond markets and policy response Policy rates in central European countries % percent point 1.5 EUR GBP CHF Yield spreads between policy rate and OIS rate <1M> EUR GBP CHF Jan-8 May-8 Sep-8 Jan-9 May-9 Sep-9 Jan-1 May Jan-8 May-8 Sep-8 Jan-9 May-9 Sep-9 Jan-1 May-1 Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 19

21 1-2. European government bond markets and policy response Possible side effects of flight to quality Some cite the risk that fund inflows to Germany and Switzerland triggered by sovereign risk in problem countries have created excessive accommodative monetary conditions. -Large cities in Switzerland are seeing a gradual acceleration of house prices, something warned about by the SNB in its June 21 Financial Stability Report (FSR). Although conditions are not yet that severe, this problem is difficult to address. -Switzerland has monetary policy flexibility, but a rate hike could accelerate fund inflows. Germany does not enjoy such freedom as a member of the EMU. -For now, the SNB has indicated in the FSR that it will instruct financial institutions to manage their loan books more carefully. Reference: SNB s Financial Stability Report (June 21; excerpt) evidence based on a comprehensive analysis of the Swiss real estate and mortgage market reveals initial signs of a build-up of risks. First, growth rates for residential real estate prices and for mortgage loan volumes are relatively high. Second, various indicators point to an increase in competition in this market. Third, quantitative and qualitative data collected by the SNB through a survey during the first quarter of 21 suggest that high risk-taking in this market is not uncommon. Even though most banks reported no relaxation of their internal lending standards between 25 and 29, banks with a significant market share have internal lending standards that stand out in terms of their lack of conservatism. Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 2

22 1-2. European government bond markets and policy response Overview of measures announced on 1 May Global financial markets (funding) EMU members BP aid facility by EU and IMF ( 6bn added for 11bn in total) <European Financial Stability Mechanism (EFSM)> European Union (newly established) SPV ( 44bn) <European Financial Stability Framework (EFSF)> Pro rata debt guarantee based on contributions to EU: requires approval of national legislature Problem countries The market appreciates the fact that this 75bn program will make it possible to put off the fundraising issue for about two years. As of the end of June, only a few EMU legislatures (thought to be Greece, Belgium, Slovakia, and Malta) had yet to approve the guarantee of the liability of the SPV. That said, there has been strong criticism that the program itself runs counter to the spirit of the Lisbon Treaty. -From a legal perspective, the EFSM involves the extension of credit and not an income transfer; the EFSF is interpreted as providing indirect disaster aid. IMF aid (max 25bn) Market participants seem to be hoping this scheme will serve as a model for the eventual unified issuance of euro government bonds. Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 21

23 1-2. European government bond markets and policy response ECB Securities Market Program The ECB announced on 1 May that it would begin buying bonds in EMU markets (both government and corporate) following a decision by the Governing Council. -The Bank said the program was intended to respond to a malfunctioning bond market as well as to restore monetary policy transmission mechanisms. -The ECB also announced it would sterilize the funds supplied in order to prevent any impact on the Bank s monetary policy stance. At least in terms of its objectives, therefore, this program has traits in common with the Fed s credit easing. -That said, one of the objectives of the Fed s credit easing program was to supply funds, whereas the ECB intends to strip out this impact by sterilizing any funds provided. Market participants recently questioned the accountability of policy decisions. -Mr. Trichet s comment after the Governing Council meeting on 6 May that the ECB had not even discussed the purchase of government bonds was criticized as undermining trust in the ECB. -Apparent discord among national central banks (NCBs) after this measure was implemented was criticized as undermining trust in the program itself. Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 22

24 1-2. European government bond markets and policy response Source: ECB Securities Market Program results and issues Purchases ( bn) Flow Stock Share of total assets Amount purchased 55.1bn Total assets 2,154.25bn Share 2.6% The main issues noted from a practical perspective are as follows: 1) Policy transparency -ECB should improve disclosure of program details (duration, amount, eligible issues, etc.) and actual purchases (as Fed s credit easing program). -This will become a bigger problem if more government bonds are added to list of eligible securities. 2) Transaction terms -Many say it is difficult for financial institutions to submit offers because ECB bids are so far away from market prices. Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 23

25 1-3. European credit markets Source: ECB ECB announces effective end to Covered Bond Purchase Program (3 June) Purchases ( bn) Flow Stock The ECB announced it had completed the 6bn in purchases announced in June 29. The ECB says details will be provided in its July monthly report, but we note that (1) purchases are not thought to have exceeded several percent of total issuance during that period; and (2) the purchase period coincided with a phase of rising bond prices. 1 Jul-9 Oct-9 Jan-1 Apr-1 Share of total assets Amount purchased 61.11bn Total assets 2,154.25bn Share 2.83% 1 NCBs, which did the actual buying, explicitly stated the covered bonds they purchased would be held until maturity. -This may be because the balance sheet impact would be relatively small compared to the Fed s purchase of MBS. Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 24

26 1-3. European credit markets Source:ECBC, Thomson Reuters Covered bond market i Boxx Index European covered bond markets (bn EUR) Covered Bond Securitized Product Financial 7 6 Mortgage Public Sector Other Mortgage Public Sector Other Mar-8 Jul-8 Nov-8 Mar-9 Jul-9 Nov-9 Mar Issuance Outstanding Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 25

27 1-3. European credit markets Source:ECB Corporate bond market 1,2 1, 8 6 Non-MFI Corporation MFI Issuance of shortterm bills (bn EUR) Non-MFI Corporation MFI 9, 8, 7, 6, 5, 4, 4 3, 2 2, 1, Jan-8 M ay-8 Sep-8 Jan-9 M ay-9 Sep-9 Jan ,5 3 Non-MFI Corporation MFI Non-MFI Corporation MFI 2, Issuance of notes and bonds (bn EUR) 1,5 1, Jan-8 May-8 Sep-8 Jan-9 May-9 Sep-9 Jan Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 26

28 1-3. European credit markets Source:Thomson Reuters Credit spreads Corporate bond spread against government bond (ratings with AAA and BBB) percent point bp CDS spread (itraxx CDX) AAA spread (DE) BBB spread (DE) AAA spread (GB) BBB spread (GB) itraxx EU (LHS) itraxx Crossover 5 Jan-8 Jun-8 Oct-8 Mar-9 Aug-9 Jan-1 Jun-1 2 Mar-8 Aug-8 Feb-9 Aug-9 Jan-1 Jul-1 Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 27

29 1-3. European credit markets 12 1 Bank lending N on-financicial C orporations Loans for Housing Consumer Credit Other 2 15 Source:ECB % Total Non-Financial Corporation Loans for Housing Consumer Credit Composition (Left:outstanding: bn EUR) (Right:growth rate:%) Jan-4 Jan-5 Jan-6 Jan-7 Jan-8 Jan-9 Jan-1 % Germany France Housing loan (growth rate: %) -5 Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 3 % Greece 25 Ireland 2 Italy Portugal 15 Spain Jan -7 Ju l-7 Jan -8 Ju l-8 Jan -9 Ju l-9 Jan -1 Jan -7 Ju l-7 Jan -8 Ju l-8 Jan-9 Ju l-9 Jan-1 Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 28

30 1-3. European credit markets Source:ECB Bank lending: demand and supply 7 Total 6 Large firms Sm all and m edium -sized firms Judgment (DI) on corporate loans (Left: Supply) (Right: Demand) Total Large firms Small and medium-sized firms -2 Jan-4 Jan-5 Jan-6 Jan-7 Jan-8 Jan-9 Jan Jan-4 Jan-5 Jan-6 Jan-7 Jan-8 Jan-9 Jan Loans for Housing Consumer credit Judgment (DI) on loans to households (Left: Supply) (Right: Demand) Loans for Housing Consumer credit -2-7 Jan-4 Jan-5 Jan-6 Jan-7 Jan-8 Jan-9 Jan-1 Jan-4 Jan-5 Jan-6 Jan-7 Jan-8 Jan-9 Jan-1 Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 29

31 1-3. European credit markets Source:ECB Bank lending rates % Corporate loans % Loans to households 7 9 Loans (to 1Y) 6.5 Loans (1Y-5Y) 8 6 Loans (5Y-) Loans for Housing (1Y to 5Y) Loans for Housing (1Y-) Consumer Credit (to 1Y) Consumer credit (1Y to 5Y) 3 Jan-4 Jan-5 Jan-6 Jan-7 Jan-8 Jan-9 Jan-1 3 Jan-4 Jan-5 Jan-6 Jan-7 Jan-8 Jan-9 Jan-1 Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 3

32 1-4. BOE purchases of government debt BOE effectively discontinued Asset Purchase Facility Source: BOE Amount purchased Duration Eligible assets Purchase method 75bn when facility announced in Sep 29 Subsequently: 1) 5bn in May 29 2) 5bn in Aug 29 3) 25bn in Nov 29 for a total of 2bn After purchases approached 2bn in Feb 21, the BOE effectively discontinued purchases of gilts by not raising the limit (it is still buying corporate bonds) Not decided when program was adopted -Was to be continued until financial markets stabilized BOE envisioned buying mostly private-sector debt (CP) when program was announced in Jan 29 -It declared it would allot 5bn for purchase of private debt Gilts and corporate bonds were added in Mar 29 -BOE declared that most of 5bn added in May 29 would be earmarked for gilts CP required to mature in less than 3mos and carry rating of A3 or higher Corporate bonds must be rated BBB or higher -No conditions placed on government-guaranteed bank debentures Despite its name, this facility became a government debt buying program Securities to be purchased from participants in BOE operations -Both new and existing issues (only existing issues in the case of corporate bonds) Price to be set by BOE based on market rates Outstanding purchases (as of end-jun 21) 2 Outstanding purchases ( mn) 25 Total: bn Gilts: bn Corporate bonds: 1.25bn Gilt(LHS) Corporate Bonds CP 2 15 Commercial paper: bn Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. Mar-9 Jun-9 Sep-9 Dec-9 Mar-1 Jun-1 31

33 1-4. BOE purchases of government debt There has been little criticism relative to the situation in the US The BOE s insistence that the purchases were a form of quantitative easing, coupled with the Bank s prior agreement with the Treasury, may have helped quell concerns. The fact that the BOE effectively discontinued the program amid rising inflation may also have been well-received. As in the US, however, the question of how to manage the government debt portfolio remains a thorny one Inasmuch as the UK fiscal deficit is drawing attention amid a growing focus on sovereign risk, BOE sales of gilts could have a substantial impact. Regardless of conditions in the real economy, the inflation rate suggests that BOE might become the first of the G4 central banks to raise rates (under Inflation-targeting scheme). -The BOE has expressed the view that very large amount of reserves is not a major obstacle because its demands can be eased by rate hikes, assuming the financial crisis has ended and financial institutions are capable of rationally taking on risk. In other words, the Bank believes that raising rates while it still holds gilts would not pose any problems. Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 32

34 1-4. BOE purchases of government debt Source: BOE BOE s balance sheet (mn GBP) 35, 3, One-Week Repo Fine-Tuning Repo 25, Long-Term Repo Standing Facility 2, 15, 1, Other Repo Credit to Government Securities Other Assets 5, Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 33

35 1-5. Foreign exchange intervention by the SNB The SNB has been intervening on the foreign exchange markets by selling the CHF since March 29. -Like the yen, the Swiss franc is seen as a safe-haven currency. It has risen throughout the financial crisis whenever stresses have emerged. -The CHF s rise began in earnest in early 28 along with the financial crisis. Since then, the CHF has also risen sharply relative to the euro (the Eurozone is economically important to Switzerland). -In response, the SNB declared it would intervene on the foreign exchange market to stabilize the CHF. It has been selling the CHF since March 29 However, intervention has had a limited impact. -Initially the CHF fell as the measure surprised the market. Subsequently, however, the CHF resumed its steady climb higher. -The euro s broad-based weakness since the end of 29 has also prompted a renewed acceleration in the CHF s effective exchange rate (the nominal effective rate is currently about 2% higher than it was at the beginning of 28). Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 34

36 1-5. Currency intervention by the SNB Source: SNB SNB suggested the slowdown of intervention after sharply increasing CHF sales this spring -Significant inflation of foreign reserves suggests the SNB would have carried out large-scale intervention in May this year. As a result, outstanding foreign reserves grew to more than $25bn, putting Switzerland on a par with some of the Asia s large foreign reserve holders. -According to the SNB, the decision to soften the stance of intervention despite continued upward pressure on the CHF was attributable to a gradual rise in medium-term inflation risks as the economic outlook for Switzerland improved. 3 Outstanding foreign reserves ($ bn) 8 Monthly change in foreign reserves ($ bn) 25 Currency Gold /5 9/7 9/9 9/11 1/1 1/3 1/5-1 9/5 9/7 9/9 9/11 1/1 1/3 1/5 Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 35

37 1-5. Currency intervention by the SNB Switzerland economy and CHF markets Source: BOE, SNB CPI inflation CPI (%) CPI (Outlook, % ) JPY USD CHF Nominal effective exchange rates /I 8/I 9/I 1/I 11/I 12/I 13/I Real GDP growth rate 95 9 Jan-8 A pr-8 A ug-8 D ec-8 M ar-9 Jul-9 N ov-9 Feb-1 Jun Real GDP (%) Real GDP (Outlook, % ) /I 8/I 9/I Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved

38 1-5. Currency intervention by the SNB Problems with SNB currency intervention 1) Accountability of objectives -Initially, intervention seemed to be intended to stabilize the foreign exchange market during the crisis. The Bank s explanations subsequently began to focus on the role of intervention as a substitute for monetary policy under the zero bound. Once deflation concerns cleared away, the SNB discontinued intervention. -However, the markets believed that intervention targeted exchange rate levels. They are watching closely to see how the SNB will react in the event of continued upward pressure on the CHF. 2) Investment of foreign reserves -With foreign reserves now accounting for significant part of SNB assets, the way in which they are invested is extremely important. Given the SNB s history of relatively transparent investment of foreign reserves, its impact on other nations stance will be closely monitored. Reference: SNB s explanation of intervention (Monetary Policy Report: March 21) Should more external shocks occur, the danger of deflation cannot be entirely ruled out It will act decisively to prevent an excessive appreciation of the Swiss franc against the euro. (Monetary Policy Assessment: June 21) Should these downside risks materialize and, via an appreciation of the Swiss franc, lead to a renewed threat of deflation, the SNB would take all the measures necessary to ensure price stability. Makeup of foreign reserves (%) Source: SNB Mar 21 Dec 29 USD 22% 3% EUR 64% 58% GBP 4% 5% JPY 7% 5% CAD 3% 2% Short-term assets 1% % Government bonds 84% 84% Other bonds 9% 9% Equities 6% 7% Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 37

39 1-6. Stress tests of European financial institutions Source:CEBS Stress tests in 29 Stress tests was initiated by the decision of ECOFIN in 29. These are managed by Commission of European Banking Supervisors (CEBS), in collaboration with European Committee and the ECB. Stress tests in 29 (launched in May, the results released in October) covered 22 major international financial institutions (holding over 6% of assets of European banking industry). CEBS announced the following aggregated results: 1) Participating institutions Tier 1 ratio would be well above 9% under the baseline scenario 2) Potential credit and trading losses (in 29-1) could amount to 4 bn EUR under the stress scenario. 3) Participating institutions Tier 1 ratio would remain above 8% and no bank falling under 6% under the stress scenario. Baseline Stress EU27 GDP growth rate -4.% -.1% -5.2% -2.7% Unemployment rate 9.4% 1.9% 9.6% 12.% EMU16 GDP growth rate -4.% -.1% -5.2% -2.7% Unemployment rate 9.9% 11.5% 1.% 12.5% US GDP growth rate -2.9%.9% -3.7% -.3% Unemployment rate 8.8% 1.2% 9.2% 11.2% EU27 US Baseline Outline of scenario for the tests in 29 Stress CRE price -13% -6% -17% -13% Housing price -8% -5% -14% -15% CRE price -15% -1% -25% -2% Housing price -15% -1% -25% -2% Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 38

40 1-6. Stress tests of European financial institutions Debate regarding stress tests (in June) CEBS announced that, as for the stress test in 21, they would disclose the test results concerning respective participating financial institutions (as well as aggregated results). Although the markets welcomed the announcement of the stress test results, the following problems were also noted: 1) Many mid-sized financial institutions were found in the financial crisis to have bad assets, but these institutions were not included in last year s framework. 2) Sovereign risk was not explicitly taken into account. Regarding the first issue, some of the national supervisory authorities indicated an expansion of the tests scope (Germany s Landesbanken and Spain s savings banks). Meanwhile, some argued that the scope of the tests should be left to the discretion of national authorities as long as standard scenarios are adopted. -In Spain s case, the restructuring measures for that country s savings banks introduced in 29 may be partly responsible (see below). The rational response to the second issue would be the application of a haircut reflecting actual market prices. But some markets are still not functioning properly, and for the EU it would be difficult to provide an explanation consistent with its support of the problem countries. Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 39

41 1-6. Stress tests of European financial institutions Source:CEBS Stress test in 21 After the consultation with supervisory authorities in the region, CEBS announced the following modification of the tests. Participating financial institutions Scenario Year 21 Year institutions -In addition to major international financial institutions, banks holding the assets approximately 5% of the local banking industry assets are included -As a result, participating institutions hold 65% of assets of the European banking industry Baseline and stress scenario are set concerning the following macro-economic indicators -GDP growth rate, unemployment rate, CPI inflation -for the areas of EU27, EMU16, and US Additional stress is assumed on the following financial indicator -Risk premium of government bond rates in European economies 22 institutions -major international financial institutions -participating institutions hold 6% of assets of the European banking industry Baseline and stress scenario are set concerning the following macro-economic indicators -GDP growth rate, unemployment rate -for the areas of EU27, EMU16, and US Additional stress is assumed on the following financial indicator -CRE price and Housing price -for the areas of EU27 and US Medium-sized bank are finally included; however, the tests may have two different purposes in effect (ie. Preventing systemic risk in European financial system and maintaining stability in local financial systems). Additional stress of sovereign risks is taken account of; however, it lacked transparency at the time of such announcement. Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 4

42 1-6. Stress tests of European financial institutions (Reference) Participating financial institutions Austria Belgium Cyprus Denmark ERSTE GROUP BANK AG RAIFFEISEN ZENTRALBANK OESTERRREICH AG (RZB) KBC GROUP DEXIA MARFIN POPULAR BANK PUBLIC CO LTD BANK OF CYPRUS PUBLIC CO LTD DANSKE BANK JYSKE BANK A/S SYDBANK A/S Germany [cont.] Greece Hungary Source:CEBS DEKABANK DEUTSCHE GIROZENTRALE WGZ BANK AG WESTDT. GENO. ZENTRALBK NATIONAL BANK OF GREECE EFG EUROBANK ERGASIAS S.A. ALPHA BANK PIRAEUS BANK GROUP AGRICULTURAL BANK OF GREECE S.A. (ATEbank) TT HELLENIC POSTBANK S.A. OTP BANK NYRT. JELZÁLOGBANK NYILVÁNOSAN MŰKÖDŐ RT. Finland France Germany OP-POHJOLA GROUP BNP PARIBAS CREDIT AGRICOLE BPCE SOCIETE GENERALE DEUTSCHE BANK AG COMMERZBANK AG HYPO REAL ESTATE HOLDING AG LANDESBANK BADEN-WÜRTTEMBERG BAYERISCHE LANDESBANK DZ BANK AG DT. ZENTRAL-GENOSSENSCHAFTSBANK NORDDEUTSCHE LANDESBANK -GZ- DEUTSCHE POSTBANK AG WESTLB AG HSH NORDBANK AG LANDESBANK HESSEN-THÜRINGEN GZ LANDESBANK BERLIN AG Ireland Italy Luxembourg Malta BANK OF IRELAND ALLIED IRISH BANKS PLC UNICREDIT INTESA SANPAOLO MONTE DEI PASCHI DI SIENA BANCO POPOLARE - S.C. UNIONE DI BANCHE ITALIANE SCPA (UBI BANCA) BANQUE ET CAISSE D'EPARGNE DE L'ETAT BANQUE RAIFFEISEN BANK OF VALLETTA (BOV) Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 41

43 1-6. Stress tests of European financial institutions (Reference) Participating financial institutions (cont.) Source:CEBS Netherlands Poland Portugal Slovenia Spain ING Bank RABOBANK GROUP ABN/ FORTIS BANK NEDERLAND (HOLDING) N.V SNS BANK POWSZECHNA KASA OSZCZĘDNOŚCI BANK POLSKI S.A. (PKO BANK POLSKI) CAIXA GERAL DE DEPÓSITOS BANCO COMERCIAL PORTUGUÊS BANCO COMERCIAL PORTUGUÊS S.A. (BCP OR MILLENNIUM BCP) ESPÍRITO SANTO FINANCIAL GROUP S.A. (ESFG) BANCO BPI NOVA LJUBLJANSKA BANKA (NLB) BANCO SANTANDER S.A. BANCO BILBAO VIZCAYA ARGENTARIA S.A. (BBVA) JUPITER CAIXA CAM BANCO POPULAR ESPAÑOL, S.A. BANCO DE SABADELL, S.A. DIADA BREOGAN Spain [cont.] Sweden UK MARE NOSTRUM BANKINTER, S.A. ESPIGA BANCA CIVICA, S.A. ANTEQUERA Y JAEN (UNICAJA) BANCO PASTOR, S.A. CAJA SOL BILBAO BIZKAIA KUTXA,AURREZKI KUTXA ETA BAHITETXEA UNNIM CAJA DE AHORROS Y M.P. DE GIPUZKOA Y SAN SEBASTIAN CAI CAJA DE AHORROS Y M.P. DE CORDOBA BANCA MARCH, S.A. BANCO GUIPUZCOANO, S.A. CAJA DE AHORROS DE VITORIA Y ALAVA CAJA DE AHORROS Y M.P. DE ONTINYENT COLONYA - CAIXA D'ESTALVIS DE POLLENSA NORDEA BANK SKANDINAVISKA ENSKILDA BANKEN AB (SEB) SVENSKA HANDELSBANKEN SWEDBANK ROYAL BANK OF SCOTLAND (RBS) HSBC HOLDINGS PLC BARCLAYS LLOYDS BANKING GROUP Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 42

44 1-6. Stress tests of European financial institutions Capital-boosting measures for undercapitalized banks The most important issue for the tests, regardless of the CEBS improvement measures, is the uncertainty surrounding the injection of public funds based on stress test results. -Following the US stress tests (May 29), most of the large financial institutions raised capital from the market, but at the very least the existence of the TARP funds served as a backstop. -In contrast, the debate surrounding the adoption of a bank tax has led many to be pessimistic about the prospect for a public funds injection based on the test results. National authorities and the European Commission have publicly expressed the view that financial institutions found to be undercapitalized should raise funds from the market. (Some have also suggested that the unused portion of the debt guarantees issued in response to the financial crisis could be tapped.) -On this point, some have noted we are entering a period in which many of the funds raised by large financial institutions during the financial crisis will mature, raising the risk of increased stress. In its June 21 Financial Stability Report, the BOE discussed the issue of rollover risk for large European financial institutions. Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 43

45 1-6. Stress tests of European financial institutions (Reference) Restructuring of Spanish saving banks In order to deal with the excess capacity from macro perspective and with the increase in bad assets from micro perspectives, Spanish government launched Fund for the Orderly Restructuring of the Banking Sector (FROB) in 29 to consolidate the saving bank industry -Saving banks had limited means for capital enhancements -FROB is managed in collaboration with Deposit Guarantee Funds Under the condition of the approval by the Bank of Spain, FROB plays the following roles: 1) For a case of merger, FROB invests in preferred shares (maturing in 5 years and paying above 7.75% interests) 2) For a case of take-over, FROB acts as an administrator Bank of Spain announced in June that they have almost completed the task of reinforcing the saving bank industry. Financial resources Legal Maximum Paid out (June 21) FROB 99 bn EUR 12 bn EUR Capital 9 bn EUR 9 bn EUR Financing 9 bn EUR 3 bn EUR DGF 5 bn EUR 5 bn EUR Source:Bank of Spain Restructuring of saving banks Involved Processing Total assets (Share %) Restructured banks trn EUR (92.1) FROB aid bn EUR (6.1) Non FROB aid bn EUR (3.7) Taken over 2 43 bn EUR (3.4) Remainders 6 12 bn EUR (8.) Total trn EUR (1.) Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 44

46 1-6. Stress tests of European financial institutions Source:BOE Estimated amount of refinance by European banks (BOE Financial Stability Report <June, 21>) Tier 1 capital ratio of major European banks (BOE Financial Stability Report <June, 21>) RHS: Ratio of the estimated amount of refinance to the average amount of refinance during the period from 25 to 27. Amount of refinance includes those raised by senior debt, subordinated debt, RMBS, government-guaranteed debt, and covered bonds. Weighted average of Tier 1 capital ratio among banks with assets equal to or larger than 1 bn USD Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved. 45

47 6 July 21 Tetsuya Inoue Chief Researcher, Center for Financial Market Research Nomura Research Institute Copyright(C) 21 Nomura Research Institute, Ltd. All rights reserved.