The View

What can explain the mysterious sell-off in global banking shares?

Traumas lying beneath the surface of the financial industry have become more apparent in the weeks since Brexit

PUBLISHED : Thursday, 14 July, 2016, 10:29am
UPDATED : Thursday, 14 July, 2016, 10:34pm

Banking crises tend to unfold in the way a Great Depression era, Ernest Hemingway’s character described going broke: “Gradually and then suddenly.” How regulators, investors and markets react to crisis may be sorely tested in the European Union. And the way regulators have dealt with past transgressions will determine how difficult decisions are confronted in the future.

The US Department of Justice recently released a 228 page report explaining that it had considered laying criminal charges on top of the fine that it dropped on HSBC for its Mexican money laundering violations in December 2012. However, the DoJ faced objections from George Osborne, Chancellor of the Exchequer, who worried about the impact of a criminal case against the country’s biggest bank on the financial markets and economy.

If HSBC had been found guilty of criminal charges, the US government would have been required to review and possibly revoke its US banking licences- a death knell for any global bank.

Osborne wrote a letter to Ben Bernanke, who was then the Federal Reserve chairman, and Timothy Geithner, the Secretary of Treasury at the time, which said, “it would risk destabilising the bank globally, with very serious implications for financial and economic stability, particularly in Europe and Asia”.

If “too big to fail” and “too hazardous to jail” is the reality in today’s financially interconnected and morally ambiguous banking system then the most important question is who will stand behind and act as the lender of last resort to systemically important financial institutions.

Presently none of them can afford to fail in any way. If they cannot go bust or be prosecuted for fear of precipitating the Apocalypse then no one should believe in the efficacy of financial reforms since the subprime crisis. Indeed, the operation of modern finance must be considered seriously flawed.

American banks like JPMorgan Chase and Citibank are regulated and putatively backed by the US government in a liquidity problem. However, as it is too big to fail or be resolved or wound down, it is not clear which government HSBC would turn to- UK or China (where it earns most of its profits), as its lender of last resort in the event of a crisis.

Actually, the banking system is not morally ambiguous; rather regulators must make morally ambiguous choices in order to prevent or stall in what is becoming a perilously unstable market.

The world’s biggest banks have experienced big retreats in market value over the past year. Deutsche Bank has lost 50 per cent of its market capitalisation this year alone and is trading at an all-time low share price. Since July last year, Citigroup has lost 30 per cent of its value and Bank of America almost 29 per cent. In Europe, Barclays has fallen almost 60 per cent and BNP Paribas is down 34 per cent. In Asia, Japan’s Mitsubishi Bank has lost half of its value and HSBC a third.

Even worse, stocks in Italy’s largest banks have fallen by as much as half since April, and Brexit has intensified the sell-off. Italy’s banks are experiencing severe trouble. They are burdened by some €360 billion of bad loans- equal to a fifth of the country’s GDP. An orderly resolution bail-in of Italian banks seems as likely as an orderly abandon ship on an Italian cruise ship.

Collectively they have only made provisions for only 45 per cent of that amount. In Italy, individual investors own close to 200 billion in Italian bank bonds. And rating agency Standard & Poor’s has slashed its outlook for most of the UK’s major banks from stable to negative following Brexit.

Last week David Folkerts-Landau, the chief economist of Deutsche Bank, called for a 150 billion bailout for European banks. The economist said European institutions should be recapitalised like a similar bailout in the US. He explained that the decline in bank stocks is only the symptom of a much more onerous problem: a dangerous mix of low growth, high debt and deflation.

However, an EU bailout violates its own cardinal rule that demands mandatory bail-ins by depositors and creditors to avoid taxpayer losses. How they will avoid a bank run in Italy is a tricky exercise. More bailouts will only accelerate the EU’s political demise.

It’s funny how Brexit appears to be more prescient only after a few weeks. But, history will eventually work out whether Cameron was the worst traitor the UK has ever known or whether he was secretly a patriot who saw his last chance to abandon a failed and undemocratic EU. Perhaps Nigel Farage will even be knighted one day.

Peter Guy is a financial writer and former international banker

This column has been amended to correct a reference to Ernest Hemmingway in the first paragraph. The quote is from dialogue that appeared in Hemmingway’s 1926 novel, The Sun Also Rises.