European Banking System still in Conflict with Basel III — European Banks, Insurers Threatened as Basel III Meets Solvency II

This is a follow-up to my early January post title Global Banking System still insolvent, as showed by Basel III and confirms the conclusion that I draw that time — I admit it was an easy one — that the global banking system was still very much insolvent (it actually is by definition...) and that it just needed a nudge to fall into the abyss once again.
  • Germany, France, Denmark Fight Basel Liquidity Rules. Note that I have already mentioned at several occasions that Denmark will go bust as they are one of the biggest debtor nation in Europe — and that could provide a good explanation as to why they never entered the Monetary Union?
  • Kangaroo Bond Sales Dry Up as Regulator Bars Bonds
  • European Bank Funding Threatened as Basel III Meets Solvency II
Is Basel III supposed to be implemented in 2015 or have they postponed it to 2019? It's not clear. But what is clear is that this is going to be after the big collapse 2.0 which I think will happen this year or maybe 2012-2013.

Here are the relevant Bloomberg reports quotes. First is about Denmark/Germany/France fighting Basel III rules:
March 9 (Bloomberg) -- Denmark is teaming up with Germany and France to fight rules it says will penalize the world’s third-largest covered bond market.
Denmark wants the European Commission to change rules set out by the Basel Committee on Banking Supervision that the Nordic country says will force lenders to sell off mortgage bonds. Ane Arnth Jensen, director of the Association of Danish Mortgage Banks, has called Basel’s reluctance to assign mortgage debt the top liquidity status “grotesque,” while Nykredit A/S Senior Vice President Jesper Berg says Denmark would face a credit crisis “the likes of which this country has never seen” if the rules aren’t changed.
Denmark’s lenders, which hold more than half the country’s $490 billion of mortgage bonds, would be forced to sell off holdings to comply with Basel’s 40 percent cap on using the top- rated securities as liquid assets, according to Arnth Jensen. Basel, which says the rule will provide lenders with more liquid assets to guard against times of financial stress, doesn’t place any limit on sovereign-debt holdings.

Denmark’s mortgage bond market is about 1 1/2 times the size of the country’s economy and more than seven times the size of the government bond market, according to the central bank. Denmark, which isn’t one of the Basel Committee’s 27 members, is one of the most vocal critics of the liquidity rules.

Trading in Denmark’s covered bonds -- securities backed by the cash flow from a pool of mortgages -- rose during the financial crisis, both in the total value of securities traded and in the median size of individual trades, central bank data show. It was easier to trade short-term mortgage bonds than government notes, the bank estimates.

Danish mortgage bonds have lost 0.6 percent this year, according to an index that doesn’t account for reinvested interest. German debt with a maturity of more than 1 year has lost 2.8 percent in price over the same period, according to a Bloomberg index.

Denmark’s government-bond market is too small by about 300 billion kroner ($56 billion) to bridge the liquidity gap the Basel rules would create, Arnth Jensen said in a December interview.
 Sales of Kangaroo Bonds are drying up due to capital rules — still Basel III...

March 14 (Bloomberg) -- Sales of bonds by top-rated overseas borrowers in Australia have evaporated following a record start to 2011 after the nation’s banking regulator ruled they don’t qualify under new international capital rules.

The World Bank, Germany’s Kreditanstalt fuer Wiederaufbau and other supranational and agency issuers have avoided the kangaroo bond market since the Australian Prudential Regulation Authority said Feb. 28 their notes can’t be considered liquid assets under Basel Committee on Banking Supervision rules. The AAA rated securities represented 27 percent of new bond sales in Australia in 2010, according to data compiled by Bloomberg.

APRA’s decision spurred the nation’s banks to purchase federal and state government securities that do qualify, pushing Australian sovereign yields to the lowest in two months. The 10- year government bond has fallen 5 basis points since the guidelines were announced, while the extra yield investors demand to own New South Wales state debt instead of government notes is at a record low.

“Supranationals were potentially the most attractive asset for bank liquidity books,” said David Plank, Sydney-based head of research at Deutsche Bank AG. “Since APRA’s decision to leave them out, semi-governments are now the default asset of choice.”

Sales of kangaroo bonds, or Australian dollar notes issued by overseas borrowers in the nation, surged 88 percent to a record A$37.3 billion ($37.8 billion) last year. Borrowers were drawn to the market by swap rates that cut funding costs once proceeds were exchanged into U.S. dollars. Bank demand for top- rated kangaroo notes rose on anticipation they would meet global capital requirements.

Under Basel rules coming into force by 2015, banks must hold enough assets that can be converted into cash to meet their needs for 30 days in a sudden crisis. APRA announced last month that only sovereign and semi-government bonds were traded in sufficiently “large, deep and active markets” to meet the criteria.

The ruling was “surprising,” said Eila Kreivi, head of funding at Luxembourg-based European Investment Bank, the third- largest issuer of kangaroo bonds last year at A$5.45 billion. “I would not agree that our bonds are not liquid enough,” she said in an e-mailed response to questions.

Some state governments have less debt than EIB and their notes aren’t traded as much in the secondary market, she said. EIB has A$18.5 billion of kangaroo bonds outstanding and last sold the notes on Feb. 23, according to data compiled by Bloomberg. Australia’s Tasmania state owes A$3.3 billion in domestic bonds, according to its website.
Yet another conflict with Basel III, this time with Solvency II and solvency for European banks:
March 29 (Bloomberg) -- European banks are being forced to sell more long-term bonds as regulators seek to prevent another financial crisis. European insurers say their own regulator will stop them from buying such debt.

Basel III’s liquidity rules mean European banks may need to raise as much as 2.3 trillion euros ($3.2 trillion) in long-term funding, according to New York-based McKinsey. Insurers, the biggest buyers of such debt, are being dissuaded from buying long-term bonds under the European Union’s Solvency II rules, which makes them more expensive to hold.

“The two bits of regulation are at tension with each other,” said Simon Hills, an executive director at the British Bankers’ Association, which represents more than 200 lenders from 60 countries. “One bit is saying you should have more funding with a longer duration and the other is saying watch out when buying this stuff if you are an insurance company. It’s a big problem for banks.”
Basel III, due to be implemented in 2019, proposes requiring banks to hold enough cash or liquid assets to meet liabilities for a year. The aim is to wean banks off the short- term funding from other lenders that dried up during the crisis and sent Lehman Brothers Holdings Inc. into bankruptcy.

European banks will have a long-term liquidity shortfall of 2.3 trillion euros in eight years based on current business models, according to McKinsey. That’s about half the banks’ total capital and liquidity deficit under Basel III. U.S. banks’ deficit is about 2.2 trillion euros, McKinsey said.

To make up these shortfalls, banks will have to issue more bonds with durations of more than one year or increase retail deposits, the management consultant said. In the past 12 months, European lenders sold $893 billion of debt with durations of five years or more, according to data compiled by Bloomberg.

Insurers hold about 60 percent of banks’ subordinated debt, making them the largest purchasers of bank bonds, according to Paul Achleitner, finance head of Munich-based Allianz SE, Europe’s biggest insurer.

The European Union’s Solvency II regulations, due to be implemented in 2013, may change that. The rules make holding long-dated corporate bonds more expensive for insurers, at a time when banks are planning on selling record amounts of debt.
Lloyds Banking Group Plc, Britain’s biggest mortgage lender, is the U.K. bank most in need of increasing its long- term funding, Maughan said. About half of the firm’s 298 billion pounds ($477 billion) of wholesale funding has a maturity of less than one year, Lloyds said in a presentation last month. Sara Evans, a Lloyds’s spokeswoman, declined to comment.
Solvency II provides the amount of capital insurers need to hold against corporate bonds is directly proportional to their maturity date, regardless of their relative returns, according to a report by Morgan Stanley and Oliver Wyman Group, a New York-based consulting firm.

Firms must hold 8.2 percent of the face value of a five- year bond in reserve in case the issuer defaults and 16.5 percent for a 10-year bond, despite the longer-dated bond returning just 200 basis points more over its life, the report said. Currently, European regulations only force insurers to hold capital against their liabilities, not their assets.

That makes it “unattractive” for insurance companies to invest in long-dated bank debt, said Allianz’s Achleitner. “You have a situation where the demand for capital is going up, but the supply of capital - in a deleveraging environment and rightfully pushed by regulatory concerns - will actually go down,” he said.

Andrew Moss, chief executive officer of London-based Aviva Plc, the U.K.’s biggest insurer by sales, said insurance companies are lobbying Brussels to relax the new rules.

“The capital required for holding long-dated corporate debt is something that needs looking at,” Moss said. “We’re still in a debate with the European Commission around that. I’m not alone in the insurance community with that thought.”
The demand for bank debt will decrease because of these two forces,” he said. “This may force the banks to seek other types of funding.”

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