The economists tasked with writing the IMF’s latest Global Financial Stability Report (GFSR), which was released on Wednesday, were quite alarming about the prospects for Europe. Here are a few of the grim highlights of their report:
(1) IMF projects huge asset sales by banks: Over the next 18 months, in order to restore their capital ratios, European banks will have to reduce their balance sheets by a staggering €2 trillion, or roughly 7% of their assets. The banks are expected to sell securities and decrease lending to businesses and households
(2) IMF says EBA estimates are too low: The GFSR’s assessment of the likely retrenchment of European banks is much more severe than the one provided by the European Banking Authority (EBA) in December. Back then, the EBA estimated that European banks needed €115 billion to bolster their capital ratios. The EBA projected that only 3% of the recapitalization would come through shrinking the banks’ balance sheets.
(3) Bank deleveraging can’t be good for economic growth: The GFSR warns that the risk of a “synchronized and large-scale deleveraging” could spark financial instability and depress economic growth.
(4) Who is going to buy those bank assets? The GFSR warned: "Such a large-scale deleveraging would have consequences well beyond the euro area. The fire sale of bank assets could have a significant impact on asset prices and market liquidity.” In other words, it could cause another global credit crunch if the banks have a tag sale and no one shows up. Of course, the buyers of last resort could be the ECB and other central banks.
One of the best ways to monitor how this is all shaping up is to track the FTSE Eurofirst 300 Banks Euro Index. Despite the dire scenario for European banks discussed in the latest GFSR, it has been relatively flat around its 200-day moving average this week. However, it is down 13.9% from this year’s high on March 19, after having rallied there very impressively by 39.7% from last year’s low on November 23. The good news is that the S&P 500 Bank Composite Index is holding up much better than the Euro banking index. This suggests that investors are less concerned about another global financial contagion. Maybe what happens in Europe will stay in Europe. I’m inclined to agree with that view.
Today’s Morning Briefing: Different Views (1) Lots of economists and views at the IMF. (2) Can there be more growth ahead if there is more financial instability? (3) Banks facing capital shortfalls will need to sell assets. (4) Guess who might be the buyer of last resort. (5) Hollande sauce. (6) From auction to auction. (7) Worth watching European bank stocks to see what they are worth. (8) Anxiety in Cleveland. (9) On balance, earnings season is a happy distraction so far. (10) When central bankers start to worry about inflation, expect another easing move. (More for subscribers.)