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Tony's Ten: Industry Round Up

29 July, 2013Tony Gandy

Card Fees

The EU Commission has again stepped into the market for card processing and interchange fees. At a time when politicians and commentators (such as John Kay with his Narrow Banking report (PDF)) are calling for a greater focus onutility banking based on transactional business, a huge source of fees from operating payments utilities will be removed. Debit card fees will be capped at 0.2% and credit card fees 0.3%. Interestingly the fees are on average highest in countries which have the most resonance with the concept of utility banking. The average German credit card payment fee is 1.8%.

It is estimated the cost to the industry will be an eye watering €4.5bn, representing over a third of the €13bn in transaction fees retailers pay banks. That makes utility banking look a little less appealing. The consequences will be interesting. It should lead to lower consumer prices for goods, but it may, that is may, lead to some banks trying to impose membership fees for holding cards. The EU, and other anti trust regulators around the world, are greatly agitated by the dominance of the two major card schemes and would really like competition to develop. However, reducing the ability of card schemes to offer their banking clients greater revenues will probably end all hope of competition developing, not that there was much hope.

It is difficult for regulators, as the natural benefits of standardisation in payments markets tends to lead to natural monopoly developing, removing the damage that this can cause in itself can undermine the possibility of new rivals developing.

And now, let’s have a couple of blasts from the pasts.

Fat Finger

One of the best Fat Finger events of recent years has finally completed its full passage. Mizuho, a giant Japanese bank formed in 2001 with the merger of Dai-Ichi Kangyo Bank, Fuji Bank and the accident prone Industrial Bank of Japan, decided to establish a securities arm to challenge traditional stockbrokers Nomura and Daiwa. In 2005 one of the dealers at its new securities companies made the classic mistake of selling 610,000 shares in J-Com at 1 yen, rather than selling 1 J-Com share at 610,000 yen.

As soon as the mistake was made other traders noticed and decided to buy the shares at this knockdown price. These days markets are order driven and automated. An order is put out on a network and other traders see those orders on their screens and bid to fulfil them (selling or buying against that order), indeed since 2005 the trend has been firmly toward computers automatically fulfilling orders according to preprogramed algorithms. Mizuho tried to retract the order when the offers to buy flooded in, but the scale of activity overwhelmed the Tokyo Stock Exchange and they could not turn it off quickly enough.

Mizuho lost over ¥40bn. It recovered ¥20bn from dealers who profited from the mistake; this is Japan after all. It sued the TSE, but a court has finally agreed the payment should be restricted to ¥10.7bn (plus some costs and other payments), as Mizuho should be responsible for 30% of the damage done.

It is one of the great Fat Finger cases; it is a shame to now see it fade into history. Still, if history has taught us anything, it is that Japanese banks will make another blunder anytime soon!

Foreign currency borrowing in Central and Eastern Europe

Maybe one of the dumbest manifestations of the credit bubble created in and by Europe was the extension of Euro and Swiss Franc mortgages and business loans to borrowers in accession states and beyond in Central and Eastern Europe. In the wake of the creation of the Euro, old credit norms were thrown to one side and we all became Germans. Everyone was assumed to be as prudent and wealth generating as the average Volk of Westphalia, and other such nonsensical stereotypes. This meant low interest rates across Europe, even in locations which had never been able to borrow at such rates. Guess what, they borrowed. People could afford to lease a Merc at interest rates sometimes half or more lower than the market norm before the Euro.

Even more nonsensically these facilities, based on historically low rates, were extended to even those countries outside of the Eurozone and indeed to countries which were not even members of the European Union. In Poland, the Baltic countries and across central Europe people were extended Euro denominated loans by, primarily, EU and Eurozone banks. But wait, there was more. If you wanted to borrow money to buy a home in a rapidly inflating housing market (caused by nothing more than a flood of cheap credit), there was an even lower interest rate one could access – Swiss Franc mortgages. People bought assets using low interest mortgages and loans based on Euro and Swiss rates.

Hungarian subsidiaries of the German subsidiaries of Austrian subsidiaries of Italian banks (honest), and many other EU banks, leant enormous amounts of money to mortgages denominated in Swiss Francs and Euros. Of course, as we have discussed in this column many times, when the financial crisis hit, the Forint and other Central and Eastern currencies collapsed and the Swiss Franc rocketed in value (and the Euro far from collapsed), meaning that people paying in Florin suddenly had massive increases in their real term Mortgage payments. Even now, years down the lines, foreign currency mortgages are valued at the equivalent of 12% of Hungary’s GDP and 20% of these are delinquent.

Still, the situation could have been much worse. The Hungarian government has not simply accepted the position. Banks argue they did nothing wrong, people borrowed to gain access to low interest rates which they have received. The Government of Hungary argues that the banks did not make it plain what the risks were. The banks’ arguments that they followed the rules makes little sense, what did the banks think was going to happen if there was a change in exchange risk? It was bound to lead to defaults which would hurt their shareholders as well as the customers. Certainly the managers of the time ignored the best interest of everyone involved except, maybe, themselves.

In 2011 the Hungarian government allowed people with such mortgages to pay them off at an artificially low exchange rate. This did not work out too well as the only people in a position to payoff these mortgages were the wealthy who were not in potential default and the impact led to further deterioration in the value Forint, creating more problems for those unable to afford to pay off these mortgages and sparking a second deep recession. On Wednesday (24 July 2013) the parliament began to debate further measures, such as ruling that exchange rate changes cannot be calculated in changes to interest and capital payment, though how this would work was not determined.

Banks are in uproar about it. I can’t help but think the problem lies more with them than anywhere else.