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Draghi and the ECB Averted a Lehman-Like Credit Crunch, For Now

Published: January 11, 2012 | 8:03 pm
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The ECB has achieved a victory of sorts, kicking the liquidity can far enough down the road to give Eurozone banks some breathing room and avert an impending credit crunch.  Through its three-year LTRO loans to banks, Mario Draghi’s ECB has managed to provide enough funding and liquidity in the region to cover 2012 debt maturities, according to a recent note by Fitch.

In part, this excess liquidity will help to depress the value of the euro even further, according to Barclays, which has a 12-month forecast of $1.20 versus the U.S. dollar.

European banks had a horrible 2011 marked by investor distrust and falling stock prices.  Apart from the constant threat of a sovereign debt implosion, European banks faced a credit crunch as U.S. money market funds cut their exposure by about 45% since May, sapping dollar liquidity and pretty much freezing interbank lending.

But Super Mario came to the rescue, and his ECB decided to inject unprecedented amounts of liquidity to prop up the banks.  Euro banks have already borrowed a little more than €500 billion ($636 billion) from the ECB, according to Dennis Gartman, and will continue to “stash” that money at the ECB’s vaults in order to “build up funds to replace maturing debt,” according to Fitch.

Collectively, these banks have about €600 billion ($763 billion) in maturing debt in 2012.  In other words, Eurozone banks are about €100 billion ($127 billion) shy of covering their total debt maturities for 2012, effectively kicking the funding can down the road until next year.

But that’s not the only problem.  In the face of a private sector that is deleveraging, these banks are being forced to beef up their capital positions, taking their core tier 1 capital ratios to 9% by June.  Analysts at Barclays estimate Eurozone bank deleveraging could range from €500 billion to €3 trillion ($636 billion to $3.8 trillion), or up to 10% of total assets.

While these institutions will have the support of the ECB in 2012, they could be forced to cut that reliance going into 2013, posing further problems for the beleaguered sector.  At the same time, relying on deleveraging to improve their capital positions could be a risky strategy given that “their ability to sell assets is likely to be significantly restricted because so many other lenders will be taking the same steps,” according to Fitch.

Banks in the U.S. aren’t looking all that pretty either.  JPMorgan Chase has a $15 billion exposure to peripheral Europe, according to its CEO Jamie Dimon, who said he wouldn’t be too angry if their losses totaled $5 billion there.  Morgan Stanley’s stock came under pressure in 2011 on rumors that its European exposure was large, and MF Global was forced into bankruptcy after excessive leverage and a bet on European sovereign debt became unmanageable.  Citi, Goldman Sachs, Wells Fargo, Bank of America, set to post earnings in coming weeks, will be under the spotlight as their numbers become public.

It will be another difficult year for banks.  A credit crunch, at least in Europe, appears to have been averted, according to Fitch.  Their conclusion, though, seems contingent on the crisis not taking a turn for the worse.

Source: Forbes



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