By SATYAJIT DAS
Published: July 25, 2016 7:41 a.m. ET
Banks worldwide are highly leveraged, leaving them vulnerable to even a small loss, which can wipe out a significant amount of capital and increase the risk of insolvency. Now a new global banking crisis may be beginning; the pieces are falling into place.
Exacerbating the danger is that in many advanced economies, banking systems are large relative to the real economy. They are vital in facilitating payments and supplying the essential credit that drives consumption, investment and government spending. Any disruption quickly results in a slowdown in the economic activity.
Today, several areas of banking stress are clear. Consider European banks, which hold around 1.2 trillion euro worth of problem loans. Italian banks alone have an estimated €360 billion of non-performing loans (“NPLs”), reflecting around 20% of Italy’s GDP. Italian NPLs represent around 15% of all its banking system’s loans, compared to around 5% in the U.S. during in the 2008-09 banking crisis. The problem is not a real estate bubble, but low growth, disinflation or deflation, and lack of competitiveness — exacerbated by an overvalued exchange rate.
Italian banks’ access to new equity is now limited. Atlante, the government established vehicle, was inadequately funded (at €4-6 billion) for the task of recapitalizing problem banks. It was also conceptually flawed, raising money from stronger banks, insurers, and institutions to support weaker entities — in effect spreading contagion.
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Resolution of insolvent banks under EU procedures requires progressively writing down equity and subordinated debt, as senior debt protects only insured deposits. However, “bailing in” creditors would result in writing down around €200 billion of securities held by retail investors, which would prove politically difficult. EU budgetary and debt limits also make it hard for the Italian government to intervene.
Other European nations are not immune. Germany’s fragmented banking sector is vulnerable, not having fully reformed after the 2008 crisis. Deutsche Bank’s share price has fallen sharply. Landesbanks, central institutions for savings banks and house banks for the German Laender (states), face rising bad debts and persistent low profitability. European banks also have varying level of exposures to Italian banks and Italian sovereign debt, as well as to other weaker European issuers.
Non-performing loan problems are also apparent in emerging markets.
China’s official bad debts are under 2% of total credit, or around 6% including “special mention” loans. That is far below independent calculations that put problem debt at around 15%-16% of total credit. The IMF estimates that China sits on $1.3 trillion of risky loans, with potential losses equivalent to 7% of GDP. Private forecasts are two- to three times this level.
For this, blame government directed lending to state-owned enterprises (“SOEs”) in an effort to finance investments needed to meet growth targets. The result: overcapacity and projects that cannot meet debt repayments. The losses are similar to previous debt cycles, but this time it’s unlikely that growth from liberalization and strong external demand can resolve China’s non-performing loan problem.
India, meanwhile, confronts stressed loans totaling more than $150 billion, around 10% of its GDP. NPLs are the result of over-leveraged borrowers, primarily SOEs, family owned conglomerates, and infrastructure firms. Governance also is a problem, with state-owned banks under pressure to lend to government-sponsored trophy projects with dubious economics. NPLs are difficult to resolve, due to historically inefficient bankruptcy procedures that have only recently been altered. Meanwhile, politically connected borrowers frequently force weak loans to be restructured rather than recognized as unrecoverable.
Brazil’s banks face delinquency rate for loans more than 90 days overdue of almost 3.5%. Expect this figure to rise further as borrowers struggle to service debt due to a brutal economic downturn, high interest rates, falling commodity prices, and a weaker currency.
Any new banking crisis likely will be significant. Banks are networked both domestically and internationally through inter-bank lending and derivative transactions. Problems at one bank can quickly infect others and spread across the financial system. Public finance problems follow as governments and central banks are forced to support banks to ensure continuance of essential payment and credit flows. The only guarantee at this point is that banking problems will remain a continued source of economic instability.
Satyajit Das is a former banker and author of The Age of Stagnation (Prometheus Books). He is also the author of “Extreme Money,” and “Traders, Guns & Money.”