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Eurozone: Stressful 'haircuts' - Peston

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http://www.bbc.co.uk/blogs/thereporters/robertpeston/2010/07/eurozone_stressful_haircuts.html

In the assessment of whether European banks are strong enough, a really important issue is what kind of discount or "haircut" should be applied to their holdings of government debt.

The final details are still being agreed. But bankers have disclosed to me that they have been told to assess the strength of their balance sheets on the basis of the following haircuts.

Greek government bonds would be written down by around 17%, Spanish sovereign debt by around 10/11%, UK government by a marginally smaller discount than on Spanish debt, French by 6%, and German by 4 or 5%.

Now two numbers stand out for me.

First, that the discount on Greek debt is only 17% - when many analysts believe it needs to be written down by nearer 50%.

And then there is the almost identical haircuts applied to Spanish and British government debt.

Now the rationale for applying similar haircuts is that both Spain and the UK had very large public sector deficits in 2009: 11.2% for Spain and 11.5% for the UK.

But, as I've pointed out before, the UK has two advantages lacked by Spain when it comes to the affordability of its debt.

First, the maturity of its existing debt is much longer than for Spain: so on top of needing to borrow to finance the gap between spending and revenues, Spain also has to refinance maturing debt equivalent to 8.7% of GDP next year, compared with 3.8% for the UK.

So from that point of view, Spain is more exposed to the whims of creditors than the UK.

Also, most economists would argue that the UK's ability to service its debts is helped by having an independent currency, which adjusts to perceptions of its economic strength, rather than being locked into the euro - as is Spain - whose value is only partly determined by the performance of the Spanish economy.

That said, according to Eurostat - the EU's statistical arm - the UK's national debt at the end of last year was 68% of GDP, compared with just 53% for Spain.

In other words, and in the round, it is difficult for the UK to argue that a significantly smaller discount should be applied to its sovereign debt in the stress tests than would apply to Spain.

Even so, it's arguably quite embarrassing for the new coalition government that European regulators believe the UK's sovereign debts are of equivalent quality to what Spain has borrowed - and significantly worse quality than French and German government bonds.

Update 1556: By the way, I have a bit of additional ammunition for those who fear that the stress tests won't be robust enough.

What I've learned is that to pass the tests, a bank has to prove that its tier 1 ratio won't fall below 6% through the stressed cycle.

Now the important point about this 6% tier 1 figure is that it's calculated according to the widely discredited Basel ll formula: in other words, banks can include in their calculations of their capital resources various forms of capital that the recent banking crisis showed were more-or-less useless for absorbing losses.

By contrast, when the UK's Financial Services Authority conducted its stress tests, it insisted that British banks' core equity (or core tier 1 capital) shouldn't fall below 4% of risk-weighted assets (loans and investments).

Most investors and lenders would regard a 4% core equity target as more demanding than a 6% Basel ll tier 1 target.

The use of the Basel ll definition is widely seen as a victory for France and for French banks, which are relatively short of pure equity in relation to their assets.

Is Peston correct that 4% core equity target is a more demanding than 6% Basel II tier 1 target?

So UK debt viewed the same as Spanish debt by the ECB, judging by some of the off balance sheet figures being banded around that might be a rather optimistic assumption for the UK.

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Is Peston correct that 4% core equity target is a more demanding than 6% Basel II tier 1 target?

So UK debt viewed the same as Spanish debt by the ECB, judging by some of the off balance sheet figures being banded around that might be a rather optimistic assumption for the UK.

If the markets believe the process lacks credibility, then whatever headline appears in an attempt to keep markets sweet will backfire - BIGtime!

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  • 150 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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