monetary policy, deleveraging and soundness of banks in the eurozone and se europe

Prof. Dr. Gligor Bishev

Monetary policy, deleveraging and soundness of banks in the Eurozone and SE

Europe

Current crisis

• Despite two and a half years of good statistics, the growth had not recovered on permanent basis

• Unlike in 2007-2008 when the crises was imported from USA, today the epicenter of the crisis is the EU:

High leverage of the public sector and, in some countries, high leverage of the private sector are requiring austerity measures while week private consumption requires measures for stimulating private spending

Sovereign risks have been transmitted to banks holding sovereign debt, thus generating again a freeze of financial flows

Higher uncertainty and restricted financing have a negative impact on growth - therefore there is a significant risk of a recession

Low or negative growth weaken debt sustainability and fiscal stability - the banking sector could also be negatively affected, thus reinforcing negative fiscal-financial interlinkages

Less space for policy interventions in both developed and emerging economies

Monetary policy actionsComparison of the Anti- recessionary monetary policy in USA and in EU

I. Conventional instruments of Monetary policy • Much stronger easing of the Monetary policy in USA boosted the

liquidity of the banking sector and recovered the economic growth

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Assets ECB (left)

Assets FED (left)

ECB Repo rate

FED funds rate

II. Need for Unconventional instruments of Monetary policy

In environment where the usage of the conventional monetary instruments is limited, because the short-term interest rates are close to zero, conducting optimal monetary policy requires the central bank to firmly commit to future monetary policy actions in order to increase the current aggregate demand. Namely, all decision makers, especially private economic agents are forward-looking, and their actions will depend not only on current monetary policy but also on monetary policy that they expect to prevail in the future. Therefore, the monetary policy makers have to use unconventional monetary instruments: to try to influence the long-term nominal interest rates and to manage the long-term growth of money supply. Thus, a decline in confidence about the future, causes optimal monetary policy to be more expansionary, as reflected in either a fall in short-term interest rates, or in an increase in the future money (N. Gregory Mankiw and Matthew Weinzierl, April 27, 2011 , pp. 4-18).


II.1 Unconventional instruments of Monetary policy in USA

1. Quantitative easing. Purchasing of financial assets, treasury and corporate bonds, directly from banks and other financial institutions in order to supply liquidity on long run and to influence the yields of long-term securities. Thus, FED supported decrease of the long-term interest rates on capital market.

2. Operation twist. This measure is supposed to lead to replacement of the FED short-term treasury bills with the long-term government bonds with maturity of 3 to 30 years in the amount of U.S. dollar 400 billion.

3. Forward looking coordination trough announcement of future stance of the monetary policy


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FED funds rate

PDCF,TALF, TARP

Quantitativeeasing

QE 1

QE 2

Octomber 2011: Operation twist

August 2011: announcing the stance of MP for the next two years

Unconventional operations of FED


II.2 Unconventional instruments of Monetary policy in Euro area

1. 12 - month long term refinancing of banks.

2. Covered bonds purchase program.

3. No forward looking coordination


Unconventional operations of ECB

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Open Market Operations

Deposit facility

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in EUR million


• However, despite the high monetary expansion, the credit growth had not recovered to support the aggregate consumption of goods and services on a permanent basis.

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ЕU (M3)

ЕU (Credit)

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Comparison between the monetary policy of USA and Euro area derives the following conclusions:

1.FED consistently and permanently is sending message for maintaining the short-term interest rates close to zero and for maintaining money supply growth of around 10%, With this FED sends clear message to the economic agents about the stance of the monetary policy in the next 2-3 years, irrespectively of the rate of inflation.

2.ECB is not clear in their measures regarding the stance of the monetary policy. Namely, just before the crisis, in 2008 ECB increased the interest rate, then followed period of interest rate reduction. In April and July 2011 ECB consecutively increased the policy interest rate, sending signals for tightening of MP, and than in November and December 2011 again loosened MP. With such measures ECB increases the uncertainty regarding the future stance of the MP and do not systematically affect the decisions of the economic agents.


Monetary policy in SE Europe and soundness of banks

Countries in South East Europe are highly integrated in Euro area:

• Two are EU members ( Romania and Bulgaria)• Three are accession countries (FY, Macedonia, Croatia-from 1 July

2012 full member, and Albania)• One is in stabilization and association agreement (Serbia)

Thus monetary developments in Euro area shape monetary policy inthese countries.


The choice of optimal monetary policy in SEE countries has become an extremely difficult, given that the monetary policy should, at the same time, achieve two conflicting goals: 1. to support the growth of the aggregate private consumption and 2. to support the deleveraging of the banking sector although there is no need of

deleveraging of Public and private sector.

CountryCapital Adequacy

RatioLoans to Deposits

NPL ratio

Serbija 20.1 135.0 11.0Albania 15.2 60.0 14.0Bulgaria 17.7 133.0 19.7Romania 14.7 125.8 18.0Turkey 17.0 105.5 3.1

FY, Macedonija 16.4 90.0 9.9

Exchange rate regime

Managed floating Floating exchange rate

Currency boardManaged floating

Floating exchange rate Fixed exchange rate

Monetary strategy

Inflation targetingInflation targetingCurrency board

Inflation targetingInflation targeting

Exchange rate targeting


2006 2010 2006 2010 2006 2010

Bulgaria 21.6 16.2 34.0 57.0 19.0 28.0Croatia 34.9 40.1 31.0 35.0 34.0 39.0Romania 12.4 30.8 15.0 18.0 14.0 22.0Turkey 46.1 41.2 23.0 32.0 9.0 14.0FY, Macedonija 32.0 24.6 19.0 27.0 7.0 18.0

Public debt to GDP Corporate debt to GDP Households debt to GDP

Public and Private Sector Indebtedness


a) Countries with floating exchange rate.

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Loans to Deposits ratio in SEE

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b) Countries with fixed exchange rate.

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Conclusions:

1. Countries in the SEE mainly follow the monetary policy of ECB, however FX inflows/ Outflows on short run determine the deviation from the respective rate of credit and money supply growth.

2. High NPL in Bulgaria and Romania and to certain extend in Albania and Serbia most probably will require write offs and consequently new capital injection in the banking sector of these countries. If capitalization is not done quickly, additional deleveraging trough credit contraction will be inevitable.

3. Having in mind the leverage of banks in Turkey and FY Macedonia it is reasonable to expect that in the coming period the credit growth in these countries will overshoot the credit growth in Euro area.

4. Indebtedness of the public and private sector in SE Europe can be assessed as acceptable and it is not likely that these sectors will have to pass trough process of deleveraging

Deleveraging in Euro areaIndebtedness of the public and private sector

Advanced economies 2010 2006 2010 2006 2010Germany 67.6 83.2 52.0 56.3 65.0 64.1France 63.7 81.7 57.0 68.0 45.0 52.0Italy 106.6 119.0 68.0 91.0 35.0 43.0Spain 39.6 60.1 109.0 147.0 75.0 82.0UK 43.4 80.0 106.3 106.4 96.0 94.1US 61.4 92.0 74.2 73.9 98.0 86.4Japan 191.3 223.1 77.0 80.0 47.0 48.0Greece 106.1 142.8 49.0 52.1 41.0 49.8Portugal 63.9 93.0 82.0 104.0 83.0 89.0Iceland 30.0 93.3 82.0 80.0 87.0 110.0

Emerging economiesBulgaria 21.6 16.2 34.0 57.0 19.0 28.0Croatia 34.9 40.1 31.0 35.0 34.0 39.0Romania 12.4 30.8 15.0 18.0 14.0 22.0Turkey 46.1 41.2 23.0 32.0 9.0 14.0Macedonia 32.0 24.6 19.0 27.0 7.0 18.0

Public debt to GDP Corporate debt to GDP Retail debt to GDP

As it can be seen from the table, indebtedness is a feature of high developed countries. The ten high developed countries have debt to GDP ratio above 80% except Spain where public debt is 60 percent of GDP. In three countries, the debt to GDP ratio exceeds 100%: Italy 119%, Japan 223%, Greece 143%, and in other three the debt exceeds 90% - Portugal, Iceland and USA. These are countries that most likely will undergo the process of deleveraging. Data also indicate a very high likelihood for ten sectors in the five economies to undergo the process of deleveraging. Those are: the retail loans in Spain (82% of GDP), UK (94% of GDP), USA (86% of GDP), Portugal (89% of GDP) and Ireland (110% of GDP) and the corporate loans in Spain (147% of GDP), UK (106.4% of GDP) and Portugal (104% of GDP). Certainly, these are only rough estimates of the volume and sectors that would require a decrease of the debt. A more comprehensive analysis would require inclusion of many other indicators (for extensive analysis see in McKinsey Global Institute, 2010)

2006

Number of Archetype episodes after Description Examples Years

a crisis (total)1 'Belt-tightening'' * Episodes where the rate of debt Finland 91-98

Most common 16(23) growth is slower than nominal Malaysia 98-08deleveraging path GDP growth, or the nominal stock US 33-37

of debt declines S. Korea 98-00

2 'High inflation'' * Periods of high inflation Spain 76-80Absence of strong 8(12) mechanically increase nominal Italy 75-87central banks, often GDP growth, thus reducing Chile 84-91in emerging markets debt/GDP ratios

3 'Massive default'' * Stock of debt decreases due to US 29-33Often after a 7(7) massive private and public sector Argentina 02-08currency crisis defaults Mexico 82-92

4 'Growing out of debt'' * Economies experience rapid (and US 38-43Often after an oil or 1(3) off-trend) real GDP growth and Nigeria 01-05war boom debt/GDP decreases Egypt 75-79

Deleveraging in Euro areaFour models of Deleveraging

Deleveraging in Euro areaFour models of Deleveraging

The “belt-tightening” model was by far the most commonly used in the period after the Great Depression. This model has been used in one half of all deleveraging episodes. If today’s economies were to follow this model, that would mean increase in interest rates, decrease of the private aggregate consumption, increase of savings and deleveraging. The fiscal policy will have to eliminate the budget deficits immediately. Under such scenario, the deleveraging would last almost a decade and would lead to contraction of economic activity within the first two to three years. The economic growth would renew after the third year. The deleveraging would start two years after the crisis. From present perspective, such scenario is very unlikely, as it would require a restrictive monetary and fiscal policy leading to new recession and increase of the unemployment in the short run.

Prolonged depression that will be caused if “belt-tightening” measures are in pace only, determine many economists, world wide to prescribe following medicine for deleveraging:1. Fiscal austerity measures

2. Higher inflation generated by loose monetary policy

3. Partial debt write offs

Deleveraging in Euro area Inflation In USA and Euro area

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United States

Euro area

Soundness of banks in the Eurozone

2011 EU-wide stress test- assumptions

The main objective of the EUR-wide stress test was to regain that shattered confidence in the stability and resilience of the banking systems

2011 EU-wide stress test

The stress test results showed that eight banks fall below the 5% (tier 1 ratio) benchmark in the adverse scenario, with an overall shortfall of EUR 2.5 bn. (four banks from Spain, two banks from Greece, one bank from Austria and one bank from Germany)However, the added value of the performed stress test assessments is questionable. The 2011 EU-wide stress test was criticized by analysts for not including the assumption of mark to market valuation of sovereign debt instruments

Soundness of banks in the Eurozone

latest estimates indicate that if the banking sectors assets are adjusted for the market value of the Sovereign debt instruments, most of the global banks present In EU will have to be recapitalized . The estimate is that the “haircuts” of the present value of the sovereign debt would decrease the capital of KBC by 87%, Commerzbank by 64%, UniCredit by 63%, Barclays by 63%, Societe Generale by 51%, Deutsche Bank by 48%, Raiffeisen Bank International by 38%, BNP Paribas by 11% and BBVA by 4% (Financial Times, October 6, 2011, p. 4). In order significant reduction of the real GDP growth to be avoided, the recapitalization should be done fast, in package for all banks, similar as the process of recapitalization made in USA during 2009

Bank

Market capitalization as of 8.12.2011 in

EUR million

BNP Paribas 52,222.68Deutsche Bank 36,808.18Societe Generale 19,867.7UniCredit 15,445.3Commerzbank AG 9,204.2NBG 1,740.1ATE Bank 593.6Alpha Bank 534.3Piraeus bank 337.3EFG Eurobank 221.7

Conclusions

1. FED consistently trough conventional and unconventional measures was stimulating the personal consumption (after the crisis in 2008) which enabled the USA economic recovery to be viable

2. ECB monetary policy was looking for long term strategy for stimulating the private consumption which resulted with short term swings of the Monetary policy which created uncertainty about the long term credit and money supply growth. Generating sustainable economic growth will require clear long term strategy for credit and money supply growth and long term interest rates.

3. Precondition for recovery of credit growth in EU on pre crisis level is cleaning up banks balance sheet and recapitalization of all globally active banks.

4. For all countries of SEE, irrespective of the exchange rate regime, EUR is the main nominal anchor and the monetary policy stance depends on Euro area monetary developments. On short run the credit growth will depend on capital inflows and the possibility to borrow internationally. In the case of Bulgaria and Romania and partly Albania and Serbia tackling NPLs and strengthening banks capital will have the most significant influence on future credit growth.

Prof. Dr. Gligor Bishev Monetary policy, deleveraging and

soundness of banks in the Eurozone and SE Europe

Thank you for your attention

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