The PIIGS banks are in difficulty due to the loss of value of the government securities in their portfolio, the reduction of funding through deposits, the fragmentation of the Eurozone interbank market, to which they no longer have access, the scarce and expensive recourse to the financing for the issuance of bonds, loan losses caused by the recession and regulatory obligations imposed by new international regulations to increase capital ratios. Therefore they struggle to finance the economic system. The extraordinary intervention of the ECB, which launched the lifesaver of the three-year double refinancing, prevented the ongoing violent credit crunch from continuing and turning into a credit crunch. But in many cases that is no longer enough. Conversely, the banks of the core countries of Euroland are inundated with capital in search of safe havens, which increase their deposits and facilitate their collection on global markets with costs at historic lows. At the same time, they deposit excess liquidity with the ECB, have capital ratios higher than required by Basel 3 and the EBA and therefore can provide abundant credit at very low rates to the private sector of their countries.
But they continue to adopt riskier business models, as shown by their leverage, which is much higher than that of peripheral country institutions. Bank deleveraging will therefore continue. Overall, Euroland's banking system has cracks that are likely to widen as the single-currency crisis deepens. The solution is to quickly recapitalize ailing institutions. But to save the Spanish banks, the Madrid government was forced to ask for European help: a 100 billion EU plan was launched, but these funds do not seem to be sufficient and have not convinced the markets, also because they increase public debt Iberian. Therefore, it is urgent to launch, faster than decided at the end of June, the banking union of Euroland, with the pooling of supervision and risks and the direct recapitalization of institutions by the EFSF-ESM funds. Finally, massive purchases of government bonds, through the anti-spread shield, would support bank balance sheets.
PIIGS banks in capital trouble
Many of the main PIIGS banks were not in compliance with the capital requirements (in relation to risk-weighted assets) formulated by the European Banking Authority (EBA) at the end of 2011: 9,0% by June 2012 in terms of Core Tier 1 (the best quality part). Temporary requests, much stricter than the Basel 3 minimums and limited to large banks. Already looking at the data recorded in the financial statements, relating to the end of September 2011, on average the Spanish and Portuguese banks (together with the Austrians) were among those with the lowest ratio (7,8%), more than one point below the minimum. The Italians were 8,4%, the French 8,8% (Table A). Furthermore, the EBA has valued the government securities in the portfolio of Euroland banks at market prices, regardless of whether they are held to be brought to maturity or not, thus implicitly considering the hypothesis of sovereign debt restructuring. Compared to the values recorded in the financial statements, normally equal to the purchase prices, this has led to large devaluations for many institutions. Very high in the PIIGS and also notable in Germany, Belgium and France, where investment in government securities of peripheral countries is concentrated in a few large institutions (which increases the risk of systemic events).
So much so that, according to EBA calculations, in almost half of the cases the banks' capital was insufficient. The capital exercise conducted by the EBA in December 2011 involved 65 large Euroland banks (5 Italian), 31 of which were asked to adjust their capital (for a total of 114,7 billion euro). Spanish institutions were the worst off: 26,2 billion for the need for recapitalization (without considering medium and small institutions), against 15,4 for the Italians, 13,1 for the Germans and 7,3 for the French.
Non-compliant institutions had to present operational plans for strengthening as early as January 2012. In some countries, such as Italy, important operations were carried out in the first half of the year to increase the capital ratio. However, the tight deadlines have put various banks in difficulty, especially the Iberian ones. In mid-July, the EBA reported that most of the large banks involved had managed to reach their 9,0% target by 30 June. Few banks remain with a lower ratio, due to lack of private resources; public interventions are being studied for these institutes to comply, albeit with a delay, with the EBA recommendations.
The banking system of every country is also made up, and in some cases above all, of medium and small institutions. In Italy, the Core Tier 1 of all banks at the end of 2011 was 0,4 points higher than that of the first 5 groups. This indicates that medium-small banks are more capitalized, an important fact for the stability of the system. In Spain, however, the widespread savings banks are in more difficulty. Among them there are not only small local companies: La Caixa is the third Spanish bank, Bankia (formerly Caja Madrid) is the fourth. The latter has reached the verge of bankruptcy: to save it, at the end of May, the Government contributed 19 billion.
European intervention instruments still inadequate
To support the entire Spanish banking system, Madrid then had to ask for a European aid plan, which took shape between June and July, for an amount of 100 billion3. The agreement provides for a series of conditions, compliance with which is subject to the disbursement of the funds. First, deep reorganizations are called for both of specific banks and of the entire financial system, the effective implementation of which will be monitored by the EU-ECCEMF troika4. Furthermore, the transfer of supervisory powers over Spanish institutions from the Banco de Espana to the troika is envisaged. The first tranche of the plan (30 billion) will be disbursed by the end of July. These first funds will initially be used as a reserve against unexpected and sudden developments. This will continue until September, when the analysis of the individual banks' needs will be completed. The main weakness of this plan is that, by involving the Spanish government, to which a European loan is disbursed, it leads to an increase in the country's public debt and ends up weighing on the sovereign spread. The EU summit of 28-29 June and subsequent agreements sealed important steps towards the European banking union, but they are slow to enter into force and incomplete. The common supervision of the institutions of the 17 Euroland countries has been assigned to the ECB, taking it away from the national authorities. However, this reform will become operational only at the beginning of 2013, if there are no hitches. It was also decided that, only from that moment, the EFSF-ESM funds will be able to directly recapitalize the banks in difficulty in the various countries, without going through a loan to national governments and therefore without raising public debts, solving the basic problem of the plan pro-Spain. Common supervision was, in practice, placed as a prerequisite for direct recapitalization, postponing the entry into the field of the latter. Furthermore, no progress has been made on the other two indispensable building blocks of the banking union: common deposit insurance and a European mechanism for the orderly liquidation of insolvent banks.
Leverage too high in core countries
Although they have higher capital ratios, banks in core countries structurally adopt riskier business models. Among the major banks in Euroland, in fact, those that still operate with very high leverage are the Germans and the French, despite the downward trend that started in 2009. In 2008, the main banks in Germany operated with an average leverage of 79, which fell to 40 in 2011. In France it was reduced from 47 to 34. But these values are still decidedly too high, which enormously increase the riskiness of their management, because they imply that a small decrease in the value of their assets is enough to eliminate the value of their capital and render them insolvent. Before going bankrupt, Lehman Brothers had a leverage of 24. The main Italian and Spanish institutions have the lowest asset/capital ratio. In Italy it dropped from 29 in 2008 to 19 in 2011; in Spain it increased slightly, to 22. From a long-term perspective, therefore, it is the large German and French institutions that have a higher risk of insolvency.
Declining deposits in peripheral countries
However, the PIIGS banks must immediately face four other significant difficulties, in addition to the devaluation of government securities in the portfolio and low capital ratios. Difficulties that reinforce each other and risk blocking the operations of many of them, and therefore the disbursement of credit to the economy. First of all, the reduction of retail deposits, through current account deposits. In May 2012 the latter were 29,3% lower in Greece than in 2010, a drain equal to 28 billion; while German banks recorded a +12,5% (+135 billion) in the same period. Precisely the dynamics of deposits is splitting the Eurozone into two groups of countries: the PIIGS, on the one hand, are suffering from the contraction; the cores, on the other hand, benefit from their anomalous increase. In some countries of the second group (Germany, but also Austria and the Netherlands) the level of deposits broke records and reached its historic peak in May 2012; conversely, several countries in the first group are recording double-digit losses compared to the peak of a few quarters ago.
All of this has important consequences for the Euroland banking sector. It undermines the ability to lend and buy assets. On the other hand, it strengthens German institutions and those of other core countries, which find themselves having greater liquidity with which to operate. These trends, except in the Greek case, appear to be medium-term, having already started in 2010, and therefore do not represent a real run on the branches. They depend on at least a couple of reasons. First reason, there is a lower capacity of households to generate savings due to the worsening economic conditions; indeed, it is often drawn upon to defend living standards. The second is that those in the PIIGS who hold higher shares of wealth are rationally reviewing the allocation of assets between the different types of domestic and foreign assets and therefore decumulate local current accounts, judged no longer risk-free, by investing in assets considered safe , even at the cost of having zero remuneration. Among the major institutions, the Spanish have a higher share of deposits made up of private customer deposits: 62,3%, against 55,1% of the Italians, 55,9% of the Germans and 49,7% of the French . In normal times, the higher this share, the higher the solidity of the loan, as demonstrated by the bankruptcies due to illiquidity of those banks which based their funding on loans obtained on the interbank market. Today, on the contrary, it is more exposed to the loss of household confidence or to their reduced ability to generate savings.
Collection too expensive for PIIGS banks
The second difficulty is caused by the crisis of confidence in the global markets, which leads to the drying up and raising of the cost of funding carried out through the issue of securities. The main Italian institutions are particularly vulnerable to this difficulty, rib of the sovereign debt crisis: for them, the bonds issued represent 30,7% of total funding, against 22,9% of the Spanish, 22,0% of the Germans and 26,4% of the French. The difficulty is generally more on the cost side than on the volume of bond placements. For Italian institutions, after having taken on negative values in 2010 (-1,1 billion), net bond issues dried up again in the summer of 2011, however showing a good recovery thereafter (+8,9 billion in 2011 , +15,6 in the first 3 months of 2012). The net issues of Spanish institutions followed a similar pattern to the Italian one (+18,2 in the first quarter of 2012, +6,8 in 2011). The situation in Portugal is much worse (-0,4 in 2012 after +1,2 in 2011) and, above all, in Ireland (-4,4 after +0,3). Negative values are not always symptoms of problems: German banks have recorded negative net issues since 2009, a sign that they have decreasing funding needs through this channel. The cost of bond funding has risen for banks across all PIIGS over the course of the crisis and remains high. This increase is passed on to the borrowers (households and businesses) and reduces the demand for credit because it is too expensive and acts as a recessive factor, retroacting, as mentioned above, on the dynamics of bank deposits. Furthermore, it erodes profitability, which is crucial for generating profits to be reinvested in higher capitalization and therefore for meeting ratios without having to resort to a market that is currently very penalizing and, above all, without having to reduce assets. A profitability which, for the major institutions and measured by the ROE (return on equity), was already very low in Italy: 4,5% in June 2011, against 9,5% in France, 11,3% in Spain, 12,0, XNUMX% in Germany. This is a structural datum, now accentuated by the crisis; in various cases, greater efficiency appears to be necessary, with a reduction in operating costs, as indicated by the Bank of Italy.
Rapid rise in bad debts and losses, not only in Spain
The third difficulty of the PIIGS banking sector is formed by the continuous increase in non-performing loans, i.e. with significant delays in the repayment of principal and in the payment of interest. This occurs above all in Spain, where bad debts reached 2012 billion euros in May 156, equal to 9,0% of loans. The upward trend started in 2008 and continued, albeit at a slower pace, in 2009-2010, accelerating again in 2011-2012 (Graph B). Most of these non-performing loans are on loans that are unlikely to be repaid to Spanish banks because they were granted to the real estate sector, inflated by a large bubble in the 2003-2007 period. With the outbreak of the latter, as happened in the USA with subprime mortgages, and following the enormous increase in unemployment, many Iberian families have stopped repaying the capital they have borrowed and the banks find themselves with asset items registered in balance sheet which are worth less and less and which further affect the capital ratios. These losses are the element that weighs the most in the Spanish banking crisis and which has forced the Government in Madrid to ask for European aid. However, the phenomenon is not confined to the Spanish economy. In Italy, for example, bad debts reached 2012 billion in May 111, 6,5% of loans.
Fragmented interbank market in Euroland
The fourth fundamental difficulty for PIIGS banks is the drying up of interbank funding. The blockade of the European interbank market means that this source today counts much more in France (24,0% of the total at the end of 2011) and Germany (22,1%), than in Italy (14,2%) and Spain (14,8 .XNUMX%). This reflects core country banks' distrust of PIIGS banks. The former are those through which more liquidity passes and which short-term loans are lent only to each other, and not to the banks of the peripheral countries. Banks in other countries outside the euro area have also progressively withdrawn funds from PIIGS banks, to which they previously lent significantly. To explain what happened in the interbank system of Euroland, let us take the example of bilateral relations between Greece and Germany. The bilateral trade balance, in deficit for Greece, determines a net flow of payments from Greek companies to German companies. This results in a flow of deposits from German exporting companies to national banks. Conversely, in Greece, banks have to finance local importers. As long as German banks provided loans to Greek ones, the circuit was closed via the interbank market. Since the beginning of the crisis, and especially as it has worsened, German banks have dried up the flow of funds to Greek institutions. Effect, in fact, of the fragmentation of the interbank market. The former have started depositing liquidity with the ECB via the Bundesbank; the latter increasingly had to borrow from the ECB through the Bank of Greece. This has progressively increased the assets of the Bundesbank in TARGET26, the payment system of Euroland, and the liabilities of the Bank of Greece also in TARGET2. This causes a strong and growing exposure of the Bundesbank (but also of other central banks) to the risk of default and, worse, of Greece's exit from the euro, as we will see better later. All this is observed for each core country and for each PIIGS, with the former accumulating surpluses in TARGET2 and the latter deficits. The interventions of the ECB, since 2009, with auctions of unlimited amounts and at fixed rates which reached their peak with the two three-year operations at the end of 2011 and the beginning of 2012 (for a gross amount of 1018 billion), made up for the collapse of the interbank market in the Eurozone and the fragmentation of the European banking system into many national systems, avoiding the collapse of many institutions in the peripheral countries. In addition to Greek banks, Portuguese, Spanish and Italian banks have also borrowed large volumes of liquidity from the ECB. The difficulty (or impossibility) in raising funds on the interbank market and the other problems of the banks mentioned above are the causes of the credit crunch in the PIIGS which started in the last months of 2011: in Greece -5,5% per annum in May 2012 loans to non-financial companies, -5,8% in Spain, -1,2% in Italy (-1,8% since September). For our country, the qualitative data from the Bank of Italy's bank lending survey clearly show that, while the supply has been reduced since the beginning of 2011, the demand for funds by businesses did not drop until the end of the year . Therefore, the reduction in the stock of business loans, which started in October 2011, was due to the decline in supply, not demand. The latter then began to decline only in 2012, following the recession also caused by the credit crunch itself. Moreover, Italian companies have run out of liquidity also due to the growing delay in payments by the PA, for which it is urgent to find a mechanism for disinvestment. Vice versa, the banks in Germany and in the other core countries, mirroring those in the PIIGS, found themselves with abundant liquidity coming from the deposits of businesses and households (not only compatriots), liquidity which, no longer wanting to use in the natural outlet of the interbank, pour elsewhere. In part, in the increase in loans to the private sector: +2,1% per annum in May 2012 for credit to German non-financial companies. The rest, parked in the ECB's Deposit Facility, which reached a record 807 billion at the beginning of July 2012, that is until it paid an interest rate, however low (0,25%). With the zeroing of this rate, the banks of the core countries keep these funds in the current account at the ECB, rather than moving them to the Deposit Facility.
Increasingly widening imbalances between national central banks
This diagram also illustrates that the ECB does not operate as a monolith, but leverages the national central banks (NCBs). By ECB statute, each Euroland bank can interface only with the NCB of the country in which it has its registered office. Therefore it is the Bank of Greece that lends to Greek banks. And it is the Bundesbank that receives the deposits of German institutions. The circle closes with the Bundesbank which is in credit to the ECB, while the Bank of Greece is in debt, under TARGET2. At the end of each day, the NCBs' bilateral debits and credits are totaled or netted and referred to the single counterparty set up by the ECB. The accumulated credits and debits of the XNUMX Euroland NCBs since the beginning of the crisis (Graph D) largely reflect current account imbalances in their respective countries and cross-country capital movements in the presence of a fragmented interbank market. The growing assets and liabilities in TARGET2 can therefore be read as revealing both the imbalances in the external accounts and the fragmentation of the Euroland interbank market, without which they would not have occurred. The Bundesbank is accumulating large claims on the ECB, at an accelerating pace. At the end of 2011 they amounted to 463 billion euros (equal to 17,9% of German GDP). During 2012 they are increasing by an average of 44 billion per month and reached a record 729 billion in June. This accumulation occurs automatically as a result of current account imbalances and above all of the movement of private capital from peripheral countries to Germany. And it determines an ever greater exposure of the Bundesbank, therefore of the German state, towards the peripheral countries themselves. In this way, Germany is already, even if it doesn't want to, financing the imbalances of the other members of the Eurozone. In addition, monetary outflows from the periphery to Germany are covered by ECB loans to banking systems suffering from the hemorrhage. If the ECB were to incur losses on these loans, these would be divided among the Eurozone countries pro-rata, based on the percentage of each NCB in the ECB's capital. For example, the Bank of Greece has accumulated significant debts with the ECB, amounting to 105 billion at the end of 2011 (48,8% of Greek GDP), precisely because it has lent to Greek banks. This suggests that, in the event of the Bank of Greece leaving the Single Monetary Mechanism, the Bundesbank would need to book a loss equal to the Bank of Greece's debt multiplied by its share in ECB capital (18,9%), i.e. around 20 billion. The loss would be calculated in the same way for all the other 15 NCBs (14,2% the share of the Bank of France, 12,5% that of the Bank of Italy).
