Sunday, October 2, 2016

Why are European banks so shaky?

..because it is relatively easy for them to evade minimum capital requirements.

Research by colleague Benjamin Munyan shows that European banks sell their debt on the last day of each quarter, temporarily turning their debt into cash, if only for one day.  On the next day, these "repo's" are bought back by the bank, turning their cash back into debt.

This "window dressing" occurs on the day when the European regulators "check" banks' debt/equity ratios.  US banks don't have this problem because US regulators check the debt/equity ratios over the entire quarter.

BOTTOM LINE:  Such window dressing "...understates a dealer bank’s leverage and maturity mismatch, which means systemic risk is higher than we would believe using only quarter-end measures."

Be careful what you measure.

2 comments:

  1. Froed,
    Thank you for bringing forward this very important topic concerning the European banks. It appears that banks by selling their debt and turn it into quick cash are actually “shorting” the process in order to avoid regulatory policies. One must wonder, what is exactly happening with the Deutsche Bank? Are they in trouble because of the existing monetary policy regime currently in place or is it related to the actual economic activities of the other European banks across the region. One can argue that investors are in it for the money and take advantage on any sign of volatility to the existing financial segment.

    In the one hand, we have the IMF and the World Banks which optimistically will have stimulus packages to move the economic and the volatility downward, but is the euro really safe? Many would argue thats not the case, we have observe currency volatility and the upcoming US job-reports could be the determining factor as more bad news are release across the European financial sector. In the other hand, we are observing that the ECB is actually pushing upward their liquidity operation across European central banks, one must wonder, what is exactly happening that the banks are turning from self-sufficient to insolvents...is this a true sign that they are in real trouble?

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  2. This practice of the bank selling their debt on the last day of each quarter or "window dressing" so that their debt to equity ratio is lower seems to be a very scary practice. Regulators will never be able to get a true and honest outlook of the bank if the bank is essentially fudging their numbers.

    While this may be common practice for most European banks, it also appears to be very fishy. The bank is essentially lying about they debt/equity ratio and making themselves looking better when the bank may very well be a high risk bank as they debt/equity ratio may be extremely high.

    While this is not the same, this type of practice reminds me of one of the biggest reasons we had the housing market crash. Selling mortgage as AAA because they were bundled in when they were really a risky buy. I fear that the European Banks will face a similar crash as they are being regulated on incorrect figures. When the Bank regulators do not have honest numbers how are they supposed to regulate, it is simply not possible for them to do their job accurately.

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