Tony's Ten: Euro Panic

01 June, 2012

Spanish Financial Minister on the Bankia case “could not be extrapolated” to the rest of the banking industry. Last Friday morning the Bankia shares were suspended as the state prepares for a €19bn bail out, though it can’t work out how it is going to pay for it. It really is scandalous that the Spanish state organised an IPO only last year for which about the only customers were small investors and savers in the banks which made up the Bankia merger.

Meanwhile, in Greece, Sandy Chen of Cenkos Securities reckons that since the beginning of 2010 about one third of retail and one half of corporate deposits in the Greek banking system have been withdrawn to the safe havens outside of the Mediterranean area. So far Spanish retail deposits have stayed at home, but there has been a 10% withdrawal of corporate deposits from the Spanish system. The central bank believes about €97bn of capital has gone overseas so far, and the rate is starting to go up. Spain is in trouble.

The withdrawal of deposits will mean that the banks will have to start cashing in some of their more liquid assets. These are usually already in the repo market, where they are temporarily sold to buy back later to gain funding, it is another form of loan financing is the shape of a sale and repurchase. If the banks start selling these assets, then they will have a longer term problem, more importantly they will flood the market with liquid assets damaging prices and causing knock on effects and that the banks that are lending through the Repo markets will want a bigger margin to cover the risks leading to a big contraction in the availability of funding through this essential market. Around €6.5tr of European bank funding comes from Repo markets and it is a big way excess funds in Germany and other countries are recycled back through the system. Probably this scenario is a distant possibility, but the ECB simply cannot afford to let it happen.

Dr Tony Gandy, Reader, Postgraduate Programmes