Looming credit crisis despite Eurozone financial bounce?
The Euro rallied strongly, alongside other risky assets on Wednesday as the heavyweight of European finance, Jose Manuel Barroso, announced a plan to end the European debt situation and force a decisive decision on the sustainability of Greece. Despite the fact that his contribution was appreciated and produced a strong rally from for riskier currencies against the dollar, it arrived at a time when doubts surrounding the substance of the promised financial stability packages remain in the eyes of many analysts.
Mr Barroso activated a plan to not only determine, once and for all, the decisive action required to remove all doubt about Greece’s financial sustainability, but also in the expedited implementation of the controversial European Stability Mechanism to replace the European Financial Stability Facility. These two pieces of news alone were enough to send the Euro and the Aussie dollar flying amongst other risk-correlated assets. The understanding is that that Greece will receive a new financial package and that will help it to pay its debts, the write down will be larger than the 21% originally agreed and many are suggesting that it could be up to 60%. Despite this, Slovakia voted against increasing the power of the EFSF, although most observers agree that this was related to internal politics and it is assumed that a further vote will have an outcome in favour of its expansion.
Although this news was a welcome relief from the piecemeal amounts of information released by the EU Commission over recent weeks in regards to a substantive plan, the questions have already started to be asked as to how Mr Barroso’s roadmap will affect European banks and the demand for credit and liquidity. Many have asked whether the supposition that the sovereign debt problem and its inherent link to national banks can be solved by throwing further amounts of money into the system and in implementing safeguards for future lending. The idea that banks will have to prove themselves healthy enough to be lent capital, using a minimum ratio of capital to assets, may adversely affect many banks in France and Germany. If this ratio was set to between 7-9% it would mean that between 50-60 big banks in the eurozone would hit a shortfall and thus perhaps not be eligible to receive much-needed credit from lenders.
Further to this, the London Interbank Offered Rate, being the 3 month loan rate that London banks can receive money, has been rising for 24 consecutive days. Applying this to the increase in safeguards outlined by the president of the European Commission and the potential restrictions in credit for those banks with a shortfall, unless they can raise enough capital privately to reassure investors they are going to have to ask governments or the EU for further bail-out money. The fear here is that this situation could result in banks not having the requisite liquidity and a spiral into another credit crisis.