The Bankwatch

Tracking the consumer evolution of financial services

Worlds banks are on edge as a result of Greek situation

A headline that is eerily reminiscent of September 2008 when markets dried up overnight following the bankruptcy of Lehman Brothers.

Collateral demand rises for interbank lending

By contrast, lending between banks without the backing of collateral has ground to a near standstill for any loans of more than a week’s duration, as fears of bank insolvency rise due to continuing uncertainty over Greece and its emergency loan payments.

The background here is that small euro banks are implicated in this for now.  The question will be what happens next and what other banks will be involved.  The changes since September 2008 are quite limited to future capital requirements. 

Much is being made about the distinction between sovereign liquidity and sovereign solvency recently.  This is a distinction made by journalists and amateurs.  Both liquidity and solvency refer to the ability to meet short term liabilities.  The corollary to ‘solvency/ liquidity’ is best described by ratios such as debt/ equity or debt coverage (ratio of cash flow to debt payments).  This applies to companies, banks and governments.  It is not rocket science and is simply the ability to repay debts over time. 

Going back to the situation now with the requirement for collateral for short term lending between banks.  This requirement is based on lack of confidence.  The loans being repaid in this situation are not long term loans to fund capital assets.  These are loans to fund working capital, ie liquidity.  In normal times banks are prepared to do this because they know the counterparty and are confident in their ability to make good the next day. 

The desire for collateral for such working capital loans is a sign of lack of confidence between banks.  This is an ominous omen. 

There is nothing in the new regulations suggested by Basel 3 that mitigates this liquidity and confidence risk between banks.

This is a hair trigger situation for the worlds banks over the coming days/ months.

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Written by Colin Henderson

July 3, 2011 at 22:41

Posted in Uncategorized

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