Old bad habits die hard: The dangerous relationship of mutual dependence between governments and banks.
By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.
In June, as the ECB cut back on its purchases of Italian government bonds, Italian commercial banks added to their holdings, continuing a trend that began in May, analysts at Dutch bank ABN report. Total holdings in June rose by €17 billion to €381 billion. That came on the heels of a €28 billion surge in May, which was the single largest month of Italian bank purchases of Italian bonds in history, according to Deutsche Bank
For the first time in a long time, Italian banks’ purchases of Italian bonds dwarfed those of the Eurosystem (the ECB and the national central banks of Eurozone countries), which in May and June bought a comparatively paltry €3.6 billion and €4 billion of multiyear Treasury bonds (BTPs) respectively, though the average maturity of its cumulative purchases was higher at just under 8 years. This happened as pressure on Italian government bonds rose following the unexpected formation of an anti-EU coalition government. In the space of two months the yields on 10-year bonds surged from 1.8% to 3.1%, and are now just below 3%.
It’s a big jump by today’s standards but still far lower than the 7.56% the Italian government was paying in November 2011, during the peak of the Eurozone debt crisis. Nonetheless, a two-year trend appears to be in the process of reversing.
By March this year, the Bank of Italy, on behalf of the ECB, had bought up over €350 billion of BTPs. At one point the scale of its holdings even overtook those of Italian banks, which had been shedding BTPs since mid-2016, making the central bank the second-largest holder of Italian bonds after insurance companies, pension funds and other financials. But now, Italian banks are once again buying BTPs hand over fist.
ABM Amro posits two possible reasons for the banks’ sudden newfound interest in Italy’s sovereign bonds:
It could be that Italian banks saw value in the securities following the sell-off, or they could have been acting as a force to stabilize the market… The behavior of the Italian banks during the sell-off suggests that they are willing to step in when other investors are selling, just as they did during the eurozone crisis.
In other words, what’s back in full swing is the so-called “Doom Loop” — when shaky banks hold too much of their country’s shaky government debt, raising the fear of contagion across the financial system if one of them stumbles. It represents a dangerous relationship of mutual dependence between governments and banks.
According to a study by the Bank for International Settlements in March, Italian government debt represents nearly 20% of Italian banks’ assets — one of the highest levels in the world. Italian banks hold around 18% of all of Italy’s public debt.
In terms of regulatory Tier 1 capital, at Italy’s two largest lenders, Unicredit and Intesa Sanpaolo, Italian government debt represents the equivalent of 145% of their tier 1 capital. At Italy’s third largest bank, Banco BPM, it’s 327%, at Monte dei Paschi di Siena’s (MPS) it’s 206%, at BPER Banca 176%, and Banca Carige 151%. If there is a problem with the Italian government debt, the banks get in trouble.
The latest quarterly earnings revealed that spiking Italian bond yields — and by definition dropping bond prices — are already eroding lenders’ capital buffers. State-owned Monte dei Paschi’s common equity Tier 1 capital ratio plummeted 140 basis points to 13% in June, partly due to the rise in government bond yields. Intesa Sanpaolo also blamed Italian bond market jitters for a 35-basis point drop in its CET1. Large Italian insurers such as Generali were also affected.
According to analysts at Equita SIM, Italy’s 10 biggest listed banks face on average a 40 basis point hit for every 100 basis point rise in the spread between Italian and German debt. That would be enough to drag the Tier 1 capital ratio of weaker lenders, such as Monte dei Paschi or Banca Carige, down to around 10% when measured on a fully-loaded basis, at which point investors begin to worry.
The spread between Italian and German debt has already risen by roughly 130 basis points since April, to 247 basis points, and is likely to edge higher, especially with the current Italian government threatening to use “tough tactics” in upcoming budget negotiations with Brussels. Last week demand for Italian bonds was apparently so weak that Italy’s Treasury Department felt compelled to buy back €950 million of BTPs.
In 2011 the spread exceeded 500 basis points. That was at the height of the Eurozone debt crisis. Shortly after, Mario Draghi promised to do “whatever it takes” to safeguard the European project — a pledge that led to the ECB’s enormous bond-buying program that included corporate and sovereign debt.
This has helped preserve a dangerous relationship of mutual dependence between governments and banks — the “Doom Loop.” When banks invest heavily in government debt, they become dependent on the government’s good performance, which is far from a given, especially in the Eurozone. Meanwhile, the governments depend on the banks to continue purchasing their debt despite the massive artificial boost to sovereign bond demand provided by the ECB’s quantitative easing program.
Both the governments and banks are also now dangerously dependent on the ECB’s largess. The ECB is already stepping out of the fray and will taper its purchases to zero later this year. Market players are expected to take up the slack. If not, bond prices will take a hit. But when it comes to a country like Italy, there are few willing market players left, other than the country’s banks and other financial institutions, but they do so at great risk to their own exceedingly fragile financial health. By Don Quijones.
Desperation is rising in Turkey’s banking sector following months of escalating political and financial instability. Benchmark interest rates have been hiked 10 percentage points so far this year to over 17%. But even that hasn’t stopped the Turkish Lira from plunging almost 25% since March. Read… Turkish Banks Scramble to Stave Off Debt Crisis, as Lira Plummets
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The Doom Loop should show up in the share prices of the Italian banks.
Intesa Sanpaolo is down ~25% from an April/May peak of 3.15/share on the Milan exchange, to a current level of 2.38.
Similar story for Unicredit, down -20% from April/May high of 17.94 to current level of 14.46.
Italy’s FTSEMIB spiked for reasons unknown earlier this year, peaking at an incomprehensible 23,890. It now stands at 21,354, and as it’s a bank-heavy index that 10.6% drop is still what I’d call getting off lightly.
This happened despite Italian banks aggressively pitching their stocks to depositors while they were quietly sinking. I was personally pitched Intesa stocks when they stood at €2.8 because “they are not going to stay there for long”. On that count the salesman was absolutely right.
Maybe they can get Ellon Musk’s cash-laden mystery investors to take these banks private instead of Tesla: why overpay for a car manufacturer when you can buy your own bank at a large discount?
I don’t understand something. Banks lend out the money they have multiple times, so how is that not reflected in their figures?
You do have a misunderstanding:
Banks don’t really lend the exact same money out multiple times without something else happening first. Money is lent out (say for home mortgages or credit card debt); the debt is bundled into various financial products and sold to (among other entities) pension funds and the ECB.
Cash raised by selling the debt is then re-cycled thru the process again. This work fine until the quality of the loans deteriorates, and, depending on recourse regulations, the bank has to write-off (some) of the debt. Obviously, the secret is to get as much of the debt off the bank balance sheet as quickly as possible so it can blow up in the pension fund…
Generally speaking, this is easier to do with consumer debt, as opposed to commercial stuff.
“Whatever it takes” was nothing more than kicking the can.
What should have happened in 2012 will happen sooner or later, only worse, given that there was no effort to fix the underlying problems.
It was like putting Band-Aids on a brain tumor.
Nobody mentioned Johnny MCCain Michael
All true. But then given the levels to which the central banksters are willing to intervene to avert fixing the problem and that they have kicked the can for 6 years (while ensuring markets just keep reaching for the moon), I would not put it past them to be able to do an encore. After all tehy have an enriched set of tools-QE, Acronym money, NIRP, ZIRP and experience in using them. Also they know from experience that savers, retirees, prudent people and tax-payers are all there waiting for their turn to be put under the bus or bail out the system as and when required. Not to mention the credit of having saved the system.
I thought we all agreed Italian & Spanish banks were just going to set out a large & always refilled basket of euros, and people could just take as much as they wanted.
Nobody in those countries pays back loans, so why bother trying? Really, this is a huge labor-saving concept.
Ed Note: the original concept was to have a much smaller basket for loan re-payment, but EVERYBODY just laughed at that, so we’ve eliminated it (yet another savings).
Italy getting anti- EU is something like a teenager living at home getting fed up with his parents.
The new populist government is already on the outs with its own minister of finance who says he is not going to blow the budget to let it hand out goodies it can’t afford. I think he used the word (in translation) ‘prudent’
Good heavens, next he’ll be saying that given Italy’s stretched finances (i.e. on the verge of collapse) the budget should be austere.
Then he will have to be fired.
If The People have democratically decided there shall be goodies, it wouldn’t be democratic to not have them.
Back when Zuma was heading the government in South Africa, he reached the point where he really couldn’t fire ANOTHER minister of finance. The currency would have taken a huge hit.
The ECB is normalizing its balance sheet and ending the flood of euros that bought Italy (and Greece) time to get their economies in order.
So the anti-EU sentiment may crystallize as an anti- euro sentiment.
If the ECB won’t give the government money, someone has to do it.
It’s often said that in spite of all its political and economic turmoil, Italy
manages to somehow always muddle through.
If the anti-EU government tries to re-institute the lira. this will be put to the test.
For one thing, the bloated, overpaid, unproductive public sector that is largely behind the anti-EU government, will react violently if that government tries to pay it in lira.
Austerity? Seriously? How did that work out for anybody who didn’t control their own currency? “Austerity” is batting a cool .000, in case you haven’t been paying attention the last fifty years.
No, Italy needs to massively blow out its budget, ditch the euro, and start printing its own money again. Shit will absolutely suck for a year or two but it’s the only way forward. The good news is, all the so-called “refugees” will flee in the face of the collapse, so Italy will be rid of that blight when it reemerges.
Seems the EURO will continue its decline
Extend and pretend what is new?
I prefer to think of it as more of a death spiral than a doom loop.
Looks like Turkey having a big effect on European Bank shares today.
“Market players are excepted to take up the slack. If not, bond prices will take a hit. ” Typo… Expected
Italy or Spain, Spain or Italy, who will wisink first, maybe ir will be both in a short time frame?
I bet both countries want to revive the idiot who thought a single currency for all of Europe was a good idea only to kill him again.
Just think about this:
Imagine the yields most Italian bonds would have to offer to find buyers instead of the pathetic interests they pay right now.
Imagine how Italy and Spain could keep their bloated real estate sectors from a well deserved crash diet.
Imagine how Italy and Spain could support oversized automotive markets in spite of stagnating real wages and contracting populations.
Imagine how the Italian and Spanish (and French) governments could keep on pouring money into useless public work projects without the ECB hitting yields on the head with a big hammer.
Still not convinced? For all people who think that a depreciating currency is some sort of panacea just think about Turkey right now. Unless your national dream is to become a low wage assembly line for foreign corporations and a budget tourism mecca it’s not exactly “a shining path towards the revolution”.
PS: Wolf, I sent you a piece this week but I fear it may have become caught in an antispam filter somewhere. I’ve already had it happen a couple of times over the last few days. If nothing was delivered, I’ll try again. If it really blows, just let me know! :-D
MCO1, I got the piece. Thank you. I just haven’t had time to look at it yet. But I will get to it later today.
Just want to let you know that some of the European banks you mention in your articles, most of which I had never heard of before, are sending us offers to lend us money. We live in the deep south, real flyover country. The latest offer was from BBVA at about ~35%, which was a lower rate than domestic lenders offer at ~39%.
I live in Naples, FL and I recently started using a BBVA card, as they offered 0% on all purchases for 18 months. So, I will use it for most of my purchases for the next 17 months, then pay it off in full. BBVA will earn zero in interest. I believe BBVA has the largest exposure to Turkey of any foreign banks. I would not want to be a BBVA shareholder, but I am happy to take advantage of their free money for a bit.