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Home > Blogs > Anthony Harrington > Make hay while the sun shines

Make hay while the sun shines

Finance Blogger: Anthony Harrington Anthony Harrington

On November 25, the German central bank, the Bundesbank, fired a warning shot across the bows of the German, and by implication the European financial sectors. The caution came in the Bank’s 2009 Financial Stability Review.

In a nutshell, the Bank’s message was a variant of “we’re not out the woods yet, my friends…” Despite some heartening news in recent weeks about various European economies emerging from the recession, what is worrying the Bundesbank is that viewed from the larger, macro perspective—what consultants like to call the “helicopter view”—the banks in Germany and elsewhere still have severe problems to contend with, with possibly up to 50% of losses still undeclared.

Speaking at the presentation of the Stability Review, Professor Hans-Helmut Kotz, a member of the Bank’s executive board, pointed out that the Bank’s own modeling shows that unless there is an unexpectedly sharp upturn in the global economy, German banks could be looking at further write downs in the range of €50 billion to €75 billion.

While the banks should be able to cover those losses from operating income, which is currently picking up well, and from existing loan-loss provisions, Kotz and the Bank want German banks to start seriously hoarding money, “expanding their capital buffers” against downside risks.

This is rather different to the UK government’s position. The government of course wants banks to improve their capital reserves, but not yet! Instead it desperately wants the banks to lend with both hands to kick start growth in the economy—without doing anything risky. The contradiction in the UK government’s position is obvious, but seemingly unavoidable. Unless the banks lend the economy is in deep trouble.

Something of the same fear can be found in the Bundesbank’s measured review. What the Bank fears most (in its words, “the most problematic scenario”) is a protracted period of stagnation in the world’s major economies. “Faced with low growth and a sharp rise in unemployment, the process of restructuring the financial sector that has been set in motion could then falter amid spiraling loan losses in both industry and in the residential and commercial real estate markets,” it warns.

This pattern, as history teaches us, is unfortunately characteristic of the period immediately following deep recessions and is what makes them so difficult for economies to break free from.

This means that governments, including the German government, which are currently engaged in “quantitative easing,” have a real challenge before them in mapping their exit from a policy of rolling the money printing presses, against real and sustained improvements in market conditions. If governments get this wrong, interest rates (and risk premiums on capital markets) could rocket upwards as central banks battle rising inflation. That of itself would throttle investment and damage growth.

Without growth, bank balance sheets are going to start looking desperate indeed. The Daily Telegraph (November 25) cites Dominique Strauss-Kahn, the head of the International Monetary Fund’s recent comment to Le Figaro that banks around the world have to date only admitted to around half of the $3.5 trillion (£2.1 trillion) of likely damage on their balance sheets.

“There are still large hidden losses: perhaps 50pc tucked away in balance sheets. The proportion is higher in Europe than in America. The history of banking crisis, notably in Japan, shows that there won’t be healthy growth again until the banks have been cleaned up completely,” he said.

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Tags: Bundesbank , capital adequacy , central banks , financial crisis , fiscal stimulus
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